Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Yongxing Special Materials Technology Co.,Ltd (SZSE:002756) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Yongxing Special Materials TechnologyLtd's Debt?

As you can see below, at the end of March 2024, Yongxing Special Materials TechnologyLtd had CN¥853.4m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥10.2b in cash, so it actually has CN¥9.37b net cash.

How Healthy Is Yongxing Special Materials TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yongxing Special Materials TechnologyLtd had liabilities of CN¥2.26b due within 12 months and liabilities of CN¥127.7m due beyond that. Offsetting these obligations, it had cash of CN¥10.2b as well as receivables valued at CN¥1.17b due within 12 months. So it can boast CN¥9.00b more liquid assets than total liabilities.

This surplus strongly suggests that Yongxing Special Materials TechnologyLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Yongxing Special Materials TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Yongxing Special Materials TechnologyLtd's load is not too heavy, because its EBIT was down 60% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Yongxing Special Materials TechnologyLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Yongxing Special Materials TechnologyLtd 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, Yongxing Special Materials TechnologyLtd recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yongxing Special Materials TechnologyLtd has CN¥9.37b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.1b, being 83% of its EBIT. So is Yongxing Special Materials TechnologyLtd'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 learn about the 4 warning signs we've spotted with Yongxing Special Materials TechnologyLtd (including 2 which are a bit concerning) .

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.

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