Warren Buffett famously said, '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 note that Huabao International Holdings Limited (HKG:336) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Huabao International Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Huabao International Holdings had CN¥219.0m of debt in June 2024, down from CN¥466.9m, one year before. However, its balance sheet shows it holds CN¥6.01b in cash, so it actually has CN¥5.79b net cash.

How Healthy Is Huabao International Holdings' Balance Sheet?

The latest balance sheet data shows that Huabao International Holdings had liabilities of CN¥934.2m due within a year, and liabilities of CN¥333.8m falling due after that. Offsetting these obligations, it had cash of CN¥6.01b as well as receivables valued at CN¥666.3m due within 12 months. So it can boast CN¥5.41b more liquid assets than total liabilities.

This excess liquidity is a great indication that Huabao International Holdings' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Huabao International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Huabao International Holdings's load is not too heavy, because its EBIT was down 58% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Huabao International Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huabao International 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. During the last three years, Huabao International Holdings produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huabao International Holdings has net cash of CN¥5.79b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥346m, being 74% of its EBIT. So is Huabao International Holdings's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 3 warning signs we've spotted with Huabao International Holdings (including 1 which is significant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.