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.' 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 Sokan New Materials Group Co., Ltd. (SHSE:688157) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. 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 Sokan New Materials Group's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Sokan New Materials Group had debt of CN¥124.8m, up from CN¥397.0k in one year. However, its balance sheet shows it holds CN¥295.8m in cash, so it actually has CN¥171.0m net cash.

A Look At Sokan New Materials Group's Liabilities

According to the last reported balance sheet, Sokan New Materials Group had liabilities of CN¥268.6m due within 12 months, and liabilities of CN¥31.3m due beyond 12 months. On the other hand, it had cash of CN¥295.8m and CN¥343.7m worth of receivables due within a year. So it can boast CN¥339.7m more liquid assets than total liabilities.

This surplus suggests that Sokan New Materials Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sokan New Materials Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Sokan New Materials Group grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sokan New Materials Group 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. Sokan New Materials Group 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, Sokan New Materials Group 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 we empathize with investors who find debt concerning, you should keep in mind that Sokan New Materials Group has net cash of CN¥171.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 88% year-on-year EBIT growth. So we are not troubled with Sokan New Materials Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Sokan New Materials Group that you should be aware of.

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.