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.' 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. Importantly, Zhejiang Jiahua Energy Chemical Industry Co.,Ltd. (SHSE:600273) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Zhejiang Jiahua Energy Chemical IndustryLtd's Debt?

As you can see below, Zhejiang Jiahua Energy Chemical IndustryLtd had CN¥691.9m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥1.23b in cash, so it actually has CN¥534.8m net cash.

How Strong Is Zhejiang Jiahua Energy Chemical IndustryLtd's Balance Sheet?

According to the last reported balance sheet, Zhejiang Jiahua Energy Chemical IndustryLtd had liabilities of CN¥2.12b due within 12 months, and liabilities of CN¥232.5m due beyond 12 months. On the other hand, it had cash of CN¥1.23b and CN¥1.50b worth of receivables due within a year. So it can boast CN¥374.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Jiahua Energy Chemical IndustryLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Zhejiang Jiahua Energy Chemical IndustryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Zhejiang Jiahua Energy Chemical IndustryLtd's load is not too heavy, because its EBIT was down 33% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhejiang Jiahua Energy Chemical IndustryLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang Jiahua Energy Chemical IndustryLtd 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. During the last three years, Zhejiang Jiahua Energy Chemical IndustryLtd produced sturdy free cash flow equating to 55% 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 it is always sensible to investigate a company's debt, in this case Zhejiang Jiahua Energy Chemical IndustryLtd has CN¥534.8m in net cash and a decent-looking balance sheet. So we are not troubled with Zhejiang Jiahua Energy Chemical IndustryLtd's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zhejiang Jiahua Energy Chemical IndustryLtd you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.