Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Qingdao Hanhe Cable Co.,Ltd (SZSE:002498) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Qingdao Hanhe CableLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Qingdao Hanhe CableLtd had debt of CN¥935.6m, up from CN¥789.0m in one year. But it also has CN¥1.51b in cash to offset that, meaning it has CN¥570.4m net cash.

How Healthy Is Qingdao Hanhe CableLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qingdao Hanhe CableLtd had liabilities of CN¥2.35b due within 12 months and liabilities of CN¥142.6m due beyond that. On the other hand, it had cash of CN¥1.51b and CN¥3.93b worth of receivables due within a year. So it actually has CN¥2.94b more liquid assets than total liabilities.

This excess liquidity suggests that Qingdao Hanhe CableLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Qingdao Hanhe CableLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Qingdao Hanhe CableLtd grew its EBIT by 8.5% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qingdao Hanhe CableLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Qingdao Hanhe CableLtd 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, Qingdao Hanhe CableLtd recorded free cash flow of 22% 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 Qingdao Hanhe CableLtd has net cash of CN¥570.4m, as well as more liquid assets than liabilities. And it also grew its EBIT by 8.5% over the last year. So is Qingdao Hanhe CableLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Qingdao Hanhe CableLtd .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.