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.' 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 can see that North Industries Group Red Arrow Co., Ltd (SZSE:000519) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is North Industries Group Red Arrow's Net Debt?

The image below, which you can click on for greater detail, shows that North Industries Group Red Arrow had debt of CN¥206.4m at the end of March 2024, a reduction from CN¥335.0m over a year. However, it does have CN¥6.04b in cash offsetting this, leading to net cash of CN¥5.84b.

A Look At North Industries Group Red Arrow's Liabilities

The latest balance sheet data shows that North Industries Group Red Arrow had liabilities of CN¥3.87b due within a year, and liabilities of CN¥781.8m falling due after that. Offsetting this, it had CN¥6.04b in cash and CN¥2.03b in receivables that were due within 12 months. So it can boast CN¥3.42b more liquid assets than total liabilities.

This excess liquidity suggests that North Industries Group Red Arrow is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that North Industries Group Red Arrow has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, North Industries Group Red Arrow grew its EBIT by 60% over the last twelve months, and that growth will make it easier to handle its debt. 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 North Industries Group Red Arrow'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, a company can only pay off debt with cold hard cash, not accounting profits. North Industries Group Red Arrow 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. Looking at the most recent three years, North Industries Group Red Arrow recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that North Industries Group Red Arrow has net cash of CN¥5.84b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 60% over the last year. So is North Industries Group Red Arrow's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in North Industries Group Red Arrow, you may well want to click here to check an interactive graph of its earnings per share history.

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.