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. As with many other companies XD Inc. (HKG:2400) makes use of debt. But the more important question is: how much risk is that debt creating?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does XD Carry?

The image below, which you can click on for greater detail, shows that XD had debt of CN¥130.6m at the end of June 2024, a reduction from CN¥1.91b over a year. But it also has CN¥2.28b in cash to offset that, meaning it has CN¥2.15b net cash.

A Look At XD's Liabilities

According to the last reported balance sheet, XD had liabilities of CN¥1.31b due within 12 months, and liabilities of CN¥142.3m due beyond 12 months. Offsetting this, it had CN¥2.28b in cash and CN¥408.9m in receivables that were due within 12 months. So it can boast CN¥1.24b more liquid assets than total liabilities.

This short term liquidity is a sign that XD could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that XD has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, XD made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥142m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if XD can strengthen its balance sheet over time. 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. XD 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. Happily for any shareholders, XD actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that XD has net cash of CN¥2.15b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥455m, being 320% of its EBIT. So we don't think XD's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with XD .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.