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. We can see that Wanxiang Qianchao Co.,Ltd. (SZSE:000559) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. 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 Wanxiang QianchaoLtd's Net Debt?

As you can see below, at the end of June 2024, Wanxiang QianchaoLtd had CN¥4.86b of debt, up from CN¥4.51b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥5.08b in cash, so it actually has CN¥219.7m net cash.

How Healthy Is Wanxiang QianchaoLtd's Balance Sheet?

We can see from the most recent balance sheet that Wanxiang QianchaoLtd had liabilities of CN¥10.6b falling due within a year, and liabilities of CN¥1.67b due beyond that. On the other hand, it had cash of CN¥5.08b and CN¥3.97b worth of receivables due within a year. So its liabilities total CN¥3.20b more than the combination of its cash and short-term receivables.

Since publicly traded Wanxiang QianchaoLtd shares are worth a total of CN¥18.5b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Wanxiang QianchaoLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Wanxiang QianchaoLtd grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Wanxiang QianchaoLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Wanxiang QianchaoLtd 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, Wanxiang QianchaoLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Wanxiang QianchaoLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥219.7m. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in CN¥944m. So we don't think Wanxiang QianchaoLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Wanxiang QianchaoLtd , and understanding them should be part of your investment process.

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.