Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, China Coal Energy Company Limited (HKG:1898) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does China Coal Energy Carry?

The image below, which you can click on for greater detail, shows that China Coal Energy had debt of CN¥71.2b at the end of March 2024, a reduction from CN¥83.4b over a year. However, it does have CN¥90.5b in cash offsetting this, leading to net cash of CN¥19.3b.

A Look At China Coal Energy's Liabilities

We can see from the most recent balance sheet that China Coal Energy had liabilities of CN¥91.3b falling due within a year, and liabilities of CN¥71.0b due beyond that. On the other hand, it had cash of CN¥90.5b and CN¥18.5b worth of receivables due within a year. So it has liabilities totalling CN¥53.3b more than its cash and near-term receivables, combined.

This deficit isn't so bad because China Coal Energy is worth a massive CN¥144.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, China Coal Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact China Coal Energy's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China Coal Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Coal Energy 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, China Coal Energy recorded free cash flow worth a fulsome 89% 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 China Coal Energy does have more liabilities than liquid assets, it also has net cash of CN¥19.3b. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥18b. So we are not troubled with China Coal Energy's debt use. 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. We've identified 2 warning signs with China Coal Energy (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.