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, Nanjing Hanrui Cobalt Co.,Ltd. (SZSE:300618) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Nanjing Hanrui CobaltLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Nanjing Hanrui CobaltLtd had CN¥1.63b of debt, an increase on CN¥1.31b, over one year. However, its balance sheet shows it holds CN¥1.80b in cash, so it actually has CN¥172.8m net cash.

How Strong Is Nanjing Hanrui CobaltLtd's Balance Sheet?

We can see from the most recent balance sheet that Nanjing Hanrui CobaltLtd had liabilities of CN¥2.33b falling due within a year, and liabilities of CN¥540.5m due beyond that. Offsetting these obligations, it had cash of CN¥1.80b as well as receivables valued at CN¥507.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥562.3m.

Given Nanjing Hanrui CobaltLtd has a market capitalization of CN¥8.03b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Nanjing Hanrui CobaltLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Nanjing Hanrui CobaltLtd grew its EBIT by 348% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Nanjing Hanrui CobaltLtd 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 company can only pay off debt with cold hard cash, not accounting profits. While Nanjing Hanrui CobaltLtd 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. Over the last three years, Nanjing Hanrui CobaltLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Nanjing Hanrui CobaltLtd has CN¥172.8m in net cash. And it impressed us with its EBIT growth of 348% over the last year. So we don't have any problem with Nanjing Hanrui CobaltLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Nanjing Hanrui CobaltLtd has 2 warning signs (and 1 which is a bit unpleasant) we think 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com