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 note that Zhejiang Dahua Technology Co., Ltd. (SZSE:002236) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhejiang Dahua Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Zhejiang Dahua Technology had debt of CN¥1.42b at the end of September 2024, a reduction from CN¥2.61b over a year. But on the other hand it also has CN¥9.33b in cash, leading to a CN¥7.91b net cash position.

How Healthy Is Zhejiang Dahua Technology's Balance Sheet?

According to the last reported balance sheet, Zhejiang Dahua Technology had liabilities of CN¥13.4b due within 12 months, and liabilities of CN¥618.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.33b as well as receivables valued at CN¥19.2b due within 12 months. So it can boast CN¥14.5b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Dahua Technology is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Zhejiang Dahua Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Zhejiang Dahua Technology has increased its EBIT by 3.0% over twelve months, which should ease any concerns about debt repayment. 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 Zhejiang Dahua Technology'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Zhejiang Dahua Technology 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, Zhejiang Dahua Technology produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Dahua Technology has CN¥7.91b in net cash and a decent-looking balance sheet. So is Zhejiang Dahua Technology's debt a risk? It doesn't seem so to us. 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, we've discovered 2 warning signs for Zhejiang Dahua Technology (1 is significant!) that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.