Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shuhua Sports Co., Ltd. (SHSE:605299) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shuhua Sports's Debt?

As you can see below, at the end of December 2023, Shuhua Sports had CN¥205.0m of debt, up from CN¥136.7m a year ago. Click the image for more detail. But it also has CN¥608.2m in cash to offset that, meaning it has CN¥403.2m net cash.

How Healthy Is Shuhua Sports' Balance Sheet?

The latest balance sheet data shows that Shuhua Sports had liabilities of CN¥567.9m due within a year, and liabilities of CN¥80.8m falling due after that. Offsetting this, it had CN¥608.2m in cash and CN¥323.9m in receivables that were due within 12 months. So it actually has CN¥283.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Shuhua Sports could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shuhua Sports boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Shuhua Sports has increased its EBIT by 5.9% over twelve months, which should ease any concerns about debt repayment. 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 Shuhua Sports 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. Shuhua Sports 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, Shuhua Sports actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shuhua Sports has CN¥403.2m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥216m, being 112% of its EBIT. So we don't think Shuhua Sports's use of debt is risky. 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. Be aware that Shuhua Sports is showing 1 warning sign in our investment analysis , you should know about...

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.