David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Quechen Silicon Chemical Co., Ltd. (SHSE:605183) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Quechen Silicon Chemical Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Quechen Silicon Chemical had debt of CN¥96.6m, up from CN¥9.56m in one year. But it also has CN¥832.4m in cash to offset that, meaning it has CN¥735.8m net cash.

A Look At Quechen Silicon Chemical's Liabilities

According to the last reported balance sheet, Quechen Silicon Chemical had liabilities of CN¥398.2m due within 12 months, and liabilities of CN¥646.7k due beyond 12 months. Offsetting these obligations, it had cash of CN¥832.4m as well as receivables valued at CN¥596.8m due within 12 months. So it can boast CN¥1.03b more liquid assets than total liabilities.

This excess liquidity suggests that Quechen Silicon Chemical is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Quechen Silicon Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Quechen Silicon Chemical saw its EBIT drop by 6.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Quechen Silicon Chemical's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Quechen Silicon Chemical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Quechen Silicon Chemical produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Quechen Silicon Chemical has net cash of CN¥735.8m, as well as more liquid assets than liabilities. So we don't have any problem with Quechen Silicon Chemical's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Quechen Silicon Chemical is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.