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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Ningbo Yongxin Optics Co.,Ltd (SHSE:603297) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 Ningbo Yongxin OpticsLtd's Debt?

The chart below, which you can click on for greater detail, shows that Ningbo Yongxin OpticsLtd had CN¥40.0m in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥939.8m in cash, so it actually has CN¥899.8m net cash.

A Look At Ningbo Yongxin OpticsLtd's Liabilities

According to the last reported balance sheet, Ningbo Yongxin OpticsLtd had liabilities of CN¥214.0m due within 12 months, and liabilities of CN¥26.6m due beyond 12 months. Offsetting this, it had CN¥939.8m in cash and CN¥230.2m in receivables that were due within 12 months. So it can boast CN¥929.4m more liquid assets than total liabilities.

This surplus suggests that Ningbo Yongxin OpticsLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ningbo Yongxin OpticsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Ningbo Yongxin OpticsLtd if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Ningbo Yongxin OpticsLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. While Ningbo Yongxin OpticsLtd 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. In the last three years, Ningbo Yongxin OpticsLtd's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Ningbo Yongxin OpticsLtd has CN¥899.8m in net cash and a decent-looking balance sheet. So we are not troubled with Ningbo Yongxin OpticsLtd's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Ningbo Yongxin OpticsLtd (1 is a bit concerning!) that you should be aware of before investing here.

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.

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