Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Doctorglasses Chain Co.,Ltd. (SZSE:300622) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Doctorglasses ChainLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Doctorglasses ChainLtd had debt of CN¥35.0m, up from none in one year. But it also has CN¥250.6m in cash to offset that, meaning it has CN¥215.6m net cash.

A Look At Doctorglasses ChainLtd's Liabilities

We can see from the most recent balance sheet that Doctorglasses ChainLtd had liabilities of CN¥325.8m falling due within a year, and liabilities of CN¥96.7m due beyond that. Offsetting these obligations, it had cash of CN¥250.6m as well as receivables valued at CN¥133.7m due within 12 months. So it has liabilities totalling CN¥38.2m more than its cash and near-term receivables, combined.

Having regard to Doctorglasses ChainLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥5.02b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Doctorglasses ChainLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that Doctorglasses ChainLtd saw its EBIT decline by 4.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Doctorglasses ChainLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Doctorglasses ChainLtd 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. Happily for any shareholders, Doctorglasses ChainLtd actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about Doctorglasses ChainLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥215.6m. And it impressed us with free cash flow of CN¥224m, being 173% of its EBIT. So we don't think Doctorglasses ChainLtd's use of debt is risky. 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. For example Doctorglasses ChainLtd has 2 warning signs (and 1 which is concerning) we think 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.