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 Suning Universal Co.,Ltd (SZSE:000718) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Suning UniversalLtd's Net Debt?

As you can see below, Suning UniversalLtd had CN¥1.79b of debt at September 2023, down from CN¥2.33b a year prior. However, it also had CN¥550.0m in cash, and so its net debt is CN¥1.24b.

A Look At Suning UniversalLtd's Liabilities

We can see from the most recent balance sheet that Suning UniversalLtd had liabilities of CN¥4.44b falling due within a year, and liabilities of CN¥973.2m due beyond that. Offsetting these obligations, it had cash of CN¥550.0m as well as receivables valued at CN¥333.4m due within 12 months. So its liabilities total CN¥4.53b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥6.86b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Suning UniversalLtd's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 3.6 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Importantly, Suning UniversalLtd's EBIT fell a jaw-dropping 39% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Suning UniversalLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Suning UniversalLtd produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We'd go so far as to say Suning UniversalLtd's EBIT growth rate was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Suning UniversalLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. For instance, we've identified 3 warning signs for Suning UniversalLtd (1 is significant) you should be aware of.

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.