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.' 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. We can see that Yadea Group Holdings Ltd. (HKG:1585) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Yadea Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Yadea Group Holdings had CN¥1.81b of debt, an increase on CN¥872.4m, over one year. But on the other hand it also has CN¥10.7b in cash, leading to a CN¥8.88b net cash position.

How Strong Is Yadea Group Holdings' Balance Sheet?

According to the last reported balance sheet, Yadea Group Holdings had liabilities of CN¥16.8b due within 12 months, and liabilities of CN¥799.1m due beyond 12 months. On the other hand, it had cash of CN¥10.7b and CN¥798.6m worth of receivables due within a year. So its liabilities total CN¥6.09b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Yadea Group Holdings has a market capitalization of CN¥29.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Yadea Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Yadea Group Holdings saw its EBIT drop by 2.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Yadea Group Holdings's ability to maintain a healthy balance sheet going forward. 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. Yadea Group Holdings 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 most recent three years, Yadea Group Holdings recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Yadea Group Holdings does have more liabilities than liquid assets, it also has net cash of CN¥8.88b. So we are not troubled with Yadea Group Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. 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 1 warning sign for Yadea Group Holdings 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.