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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies UE Furniture Co., Ltd. (SHSE:603600) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 UE Furniture's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 UE Furniture had CN¥753.0m of debt, an increase on CN¥301.7m, over one year. However, it does have CN¥838.2m in cash offsetting this, leading to net cash of CN¥85.1m.

A Look At UE Furniture's Liabilities

According to the last reported balance sheet, UE Furniture had liabilities of CN¥1.71b due within 12 months, and liabilities of CN¥70.1m due beyond 12 months. On the other hand, it had cash of CN¥838.2m and CN¥717.9m worth of receivables due within a year. So its liabilities total CN¥225.2m more than the combination of its cash and short-term receivables.

Of course, UE Furniture has a market capitalization of CN¥4.17b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, UE Furniture boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that UE Furniture saw its EBIT decline by 8.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if UE Furniture can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While UE Furniture 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. Looking at the most recent three years, UE Furniture recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about UE Furniture's liabilities, but we can be reassured by the fact it has has net cash of CN¥85.1m. So we are not troubled with UE Furniture's debt use. 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. Case in point: We've spotted 2 warning signs for UE Furniture you should be aware of, and 1 of them makes us a bit uncomfortable.

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.