Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Zhejiang Dun'an Artificial Environment Co., Ltd (SZSE:002011) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 Zhejiang Dun'an Artificial Environment's Net Debt?

As you can see below, at the end of September 2024, Zhejiang Dun'an Artificial Environment had CN¥1.77b of debt, up from CN¥1.37b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.70b in cash, so it actually has CN¥932.7m net cash.

How Strong Is Zhejiang Dun'an Artificial Environment's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Dun'an Artificial Environment had liabilities of CN¥5.75b falling due within a year, and liabilities of CN¥766.0m due beyond that. Offsetting these obligations, it had cash of CN¥2.70b as well as receivables valued at CN¥5.13b due within 12 months. So it actually has CN¥1.32b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Dun'an Artificial Environment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Dun'an Artificial Environment has more cash than debt is arguably a good indication that it can manage its debt safely.

Fortunately, Zhejiang Dun'an Artificial Environment grew its EBIT by 9.5% in the last year, making that debt load look even more manageable. 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 Dun'an Artificial Environment'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhejiang Dun'an Artificial Environment 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 most recent three years, Zhejiang Dun'an Artificial Environment recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Dun'an Artificial Environment has net cash of CN¥932.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in CN¥1.2b. So we don't think Zhejiang Dun'an Artificial Environment's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Zhejiang Dun'an Artificial Environment's earnings per share history for free.

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.