Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Yongxing Special Materials Technology Co.,Ltd (SZSE:002756) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does Yongxing Special Materials TechnologyLtd Carry?

As you can see below, at the end of September 2024, Yongxing Special Materials TechnologyLtd had CN¥255.0m of debt, up from CN¥230.2m a year ago. Click the image for more detail. However, it does have CN¥8.58b in cash offsetting this, leading to net cash of CN¥8.33b.

How Strong Is Yongxing Special Materials TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Yongxing Special Materials TechnologyLtd had liabilities of CN¥1.05b due within a year, and liabilities of CN¥133.2m falling due after that. Offsetting these obligations, it had cash of CN¥8.58b as well as receivables valued at CN¥807.8m due within 12 months. So it can boast CN¥8.21b more liquid assets than total liabilities.

This surplus strongly suggests that Yongxing Special Materials TechnologyLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Yongxing Special Materials TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Yongxing Special Materials TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 80% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Yongxing Special Materials TechnologyLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. Yongxing Special Materials TechnologyLtd 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. During the last three years, Yongxing Special Materials TechnologyLtd generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yongxing Special Materials TechnologyLtd has net cash of CN¥8.33b, as well as more liquid assets than liabilities. The cherry on top was that in converted 81% of that EBIT to free cash flow, bringing in CN¥612m. So is Yongxing Special Materials TechnologyLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Yongxing Special Materials TechnologyLtd you should be aware of, and 1 of them shouldn't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.