Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Huaibei Mining Holdings Co.,Ltd. (SHSE:600985) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Huaibei Mining HoldingsLtd's Debt?

As you can see below, Huaibei Mining HoldingsLtd had CN¥6.85b of debt at March 2024, down from CN¥13.3b a year prior. But it also has CN¥8.11b in cash to offset that, meaning it has CN¥1.25b net cash.

A Look At Huaibei Mining HoldingsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Huaibei Mining HoldingsLtd had liabilities of CN¥26.4b due within 12 months and liabilities of CN¥14.5b due beyond that. Offsetting these obligations, it had cash of CN¥8.11b as well as receivables valued at CN¥5.98b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥26.8b.

This is a mountain of leverage relative to its market capitalization of CN¥38.9b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Huaibei Mining HoldingsLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Huaibei Mining HoldingsLtd's load is not too heavy, because its EBIT was down 32% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Huaibei Mining HoldingsLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Huaibei Mining HoldingsLtd 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. During the last three years, Huaibei Mining HoldingsLtd generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While Huaibei Mining HoldingsLtd does have more liabilities than liquid assets, it also has net cash of CN¥1.25b. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥5.3b. So we are not troubled with Huaibei Mining HoldingsLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Huaibei Mining HoldingsLtd 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.

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