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 note that Advanced Fiber Resources (Zhuhai), Ltd. (SZSE:300620) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Advanced Fiber Resources (Zhuhai)'s Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Advanced Fiber Resources (Zhuhai) had CN¥304.4m of debt, an increase on none, over one year. But it also has CN¥719.6m in cash to offset that, meaning it has CN¥415.3m net cash.

How Strong Is Advanced Fiber Resources (Zhuhai)'s Balance Sheet?

The latest balance sheet data shows that Advanced Fiber Resources (Zhuhai) had liabilities of CN¥496.7m due within a year, and liabilities of CN¥317.6m falling due after that. Offsetting this, it had CN¥719.6m in cash and CN¥457.7m in receivables that were due within 12 months. So it actually has CN¥363.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Advanced Fiber Resources (Zhuhai) could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Advanced Fiber Resources (Zhuhai) boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Advanced Fiber Resources (Zhuhai) made a loss at the EBIT level, last year, it was also good to see that it generated CN¥50m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Advanced Fiber Resources (Zhuhai)'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Advanced Fiber Resources (Zhuhai) 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. Over the most recent year, Advanced Fiber Resources (Zhuhai) recorded free cash flow worth 57% 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 we empathize with investors who find debt concerning, you should keep in mind that Advanced Fiber Resources (Zhuhai) has net cash of CN¥415.3m, as well as more liquid assets than liabilities. So is Advanced Fiber Resources (Zhuhai)'s debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Advanced Fiber Resources (Zhuhai) that you should be aware of.

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.