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 can see that Yantai Zhenghai Magnetic Material Co., Ltd. (SZSE:300224) does use debt in its business. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Yantai Zhenghai Magnetic Material's Debt?

As you can see below, Yantai Zhenghai Magnetic Material had CN¥1.21b of debt at March 2024, down from CN¥1.28b a year prior. However, it does have CN¥2.20b in cash offsetting this, leading to net cash of CN¥987.1m.

How Strong Is Yantai Zhenghai Magnetic Material's Balance Sheet?

According to the last reported balance sheet, Yantai Zhenghai Magnetic Material had liabilities of CN¥3.17b due within 12 months, and liabilities of CN¥1.32b due beyond 12 months. Offsetting this, it had CN¥2.20b in cash and CN¥2.17b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥121.5m.

This state of affairs indicates that Yantai Zhenghai Magnetic Material'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¥8.99b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Yantai Zhenghai Magnetic Material boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Yantai Zhenghai Magnetic Material has increased its EBIT by 2.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yantai Zhenghai Magnetic Material's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Yantai Zhenghai Magnetic Material 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. Considering the last three years, Yantai Zhenghai Magnetic Material actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Yantai Zhenghai Magnetic Material has CN¥987.1m in net cash. On top of that, it increased its EBIT by 2.8% in the last twelve months. So we are not troubled with Yantai Zhenghai Magnetic Material's debt use. 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. We've identified 1 warning sign with Yantai Zhenghai Magnetic Material , and understanding them should be part of your investment process.

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.