Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that WuXi Xinje Electric Co.,Ltd. (SHSE:603416) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does WuXi Xinje ElectricLtd Carry?

As you can see below, at the end of September 2023, WuXi Xinje ElectricLtd had CN¥111.5m of debt, up from none a year ago. Click the image for more detail. But it also has CN¥1.26b in cash to offset that, meaning it has CN¥1.15b net cash.

How Healthy Is WuXi Xinje ElectricLtd's Balance Sheet?

According to the last reported balance sheet, WuXi Xinje ElectricLtd had liabilities of CN¥894.8m due within 12 months, and liabilities of CN¥33.2m due beyond 12 months. Offsetting this, it had CN¥1.26b in cash and CN¥386.7m in receivables that were due within 12 months. So it can boast CN¥720.8m more liquid assets than total liabilities.

This excess liquidity suggests that WuXi Xinje ElectricLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that WuXi Xinje ElectricLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that WuXi Xinje ElectricLtd has increased its EBIT by 9.3% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if WuXi Xinje ElectricLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. WuXi Xinje ElectricLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, WuXi Xinje ElectricLtd recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that WuXi Xinje ElectricLtd has net cash of CN¥1.15b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 9.3% in the last twelve months. So is WuXi Xinje ElectricLtd's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of WuXi Xinje ElectricLtd's earnings per share history for free.

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.