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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Zhejiang Wansheng Co., Ltd. (SHSE:603010) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Zhejiang Wansheng's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Zhejiang Wansheng had CN¥828.2m of debt, an increase on CN¥780.3m, over one year. But on the other hand it also has CN¥1.32b in cash, leading to a CN¥492.3m net cash position.

How Healthy Is Zhejiang Wansheng's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Wansheng had liabilities of CN¥1.19b falling due within a year, and liabilities of CN¥923.0m due beyond that. On the other hand, it had cash of CN¥1.32b and CN¥567.5m worth of receivables due within a year. So it has liabilities totalling CN¥220.7m more than its cash and near-term receivables, combined.

Given Zhejiang Wansheng has a market capitalization of CN¥5.68b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Zhejiang Wansheng also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Zhejiang Wansheng's load is not too heavy, because its EBIT was down 49% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Zhejiang Wansheng can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhejiang Wansheng 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. Over the last three years, Zhejiang Wansheng saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Zhejiang Wansheng has CN¥492.3m in net cash. So while Zhejiang Wansheng does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zhejiang Wansheng is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.