David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Poly Plastic Masterbatch (SuZhou) Co.,Ltd (SZSE:300905) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Poly Plastic Masterbatch (SuZhou)Ltd's Debt?

As you can see below, at the end of June 2024, Poly Plastic Masterbatch (SuZhou)Ltd had CN¥26.9m of debt, up from CN¥13.9m a year ago. Click the image for more detail. But on the other hand it also has CN¥377.0m in cash, leading to a CN¥350.1m net cash position.

A Look At Poly Plastic Masterbatch (SuZhou)Ltd's Liabilities

According to the last reported balance sheet, Poly Plastic Masterbatch (SuZhou)Ltd had liabilities of CN¥193.7m due within 12 months, and liabilities of CN¥6.53m due beyond 12 months. Offsetting this, it had CN¥377.0m in cash and CN¥340.6m in receivables that were due within 12 months. So it can boast CN¥517.4m more liquid assets than total liabilities.

This surplus suggests that Poly Plastic Masterbatch (SuZhou)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Poly Plastic Masterbatch (SuZhou)Ltd has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Poly Plastic Masterbatch (SuZhou)Ltd grew its EBIT by 119% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is Poly Plastic Masterbatch (SuZhou)Ltd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Poly Plastic Masterbatch (SuZhou)Ltd 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 last three years, Poly Plastic Masterbatch (SuZhou)Ltd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Poly Plastic Masterbatch (SuZhou)Ltd has CN¥350.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 119% over the last year. So we don't have any problem with Poly Plastic Masterbatch (SuZhou)Ltd's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Poly Plastic Masterbatch (SuZhou)Ltd (including 2 which are potentially serious) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.