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. We note that Hangzhou Cogeneration Group Co., Ltd. (SHSE:605011) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hangzhou Cogeneration Group's Net Debt?

The image below, which you can click on for greater detail, shows that Hangzhou Cogeneration Group had debt of CN¥728.9m at the end of September 2023, a reduction from CN¥1.13b over a year. But on the other hand it also has CN¥773.4m in cash, leading to a CN¥44.5m net cash position.

A Look At Hangzhou Cogeneration Group's Liabilities

According to the last reported balance sheet, Hangzhou Cogeneration Group had liabilities of CN¥797.0m due within 12 months, and liabilities of CN¥371.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥773.4m as well as receivables valued at CN¥354.9m due within 12 months. So its liabilities total CN¥40.0m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Hangzhou Cogeneration Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥9.27b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Hangzhou Cogeneration Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Hangzhou Cogeneration Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Hangzhou Cogeneration Group 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 company can only pay off debt with cold hard cash, not accounting profits. While Hangzhou Cogeneration Group 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. During the last three years, Hangzhou Cogeneration Group generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Hangzhou Cogeneration Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥44.5m. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in CN¥311m. So we don't think Hangzhou Cogeneration Group's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Hangzhou Cogeneration Group that you should be aware of.

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.