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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hangzhou Honghua Digital Technology Stock Company LTD. (SHSE:688789) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Hangzhou Honghua Digital Technology Stock Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Hangzhou Honghua Digital Technology Stock had CN¥117.7m of debt, an increase on CN¥10.3m, over one year. However, its balance sheet shows it holds CN¥1.07b in cash, so it actually has CN¥950.3m net cash.

A Look At Hangzhou Honghua Digital Technology Stock's Liabilities

We can see from the most recent balance sheet that Hangzhou Honghua Digital Technology Stock had liabilities of CN¥546.6m falling due within a year, and liabilities of CN¥63.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.07b as well as receivables valued at CN¥576.4m due within 12 months. So it can boast CN¥1.03b more liquid assets than total liabilities.

This short term liquidity is a sign that Hangzhou Honghua Digital Technology Stock could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hangzhou Honghua Digital Technology Stock boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Hangzhou Honghua Digital Technology Stock has boosted its EBIT by 52%, thus reducing the spectre of future debt repayments. 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 Hangzhou Honghua Digital Technology Stock 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. Hangzhou Honghua Digital Technology Stock 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, Hangzhou Honghua Digital Technology Stock saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hangzhou Honghua Digital Technology Stock has net cash of CN¥950.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 52% over the last year. So we are not troubled with Hangzhou Honghua Digital Technology Stock's debt use. 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. Be aware that Hangzhou Honghua Digital Technology Stock is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.