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 Yueyang Xingchang Petro-Chemical Co., Ltd. (SZSE:000819) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

What Is Yueyang Xingchang Petro-Chemical's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Yueyang Xingchang Petro-Chemical had debt of CN¥378.3m, up from CN¥160.6m in one year. However, it does have CN¥616.0m in cash offsetting this, leading to net cash of CN¥237.7m.

How Healthy Is Yueyang Xingchang Petro-Chemical's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yueyang Xingchang Petro-Chemical had liabilities of CN¥539.9m due within 12 months and liabilities of CN¥319.5m due beyond that. Offsetting these obligations, it had cash of CN¥616.0m as well as receivables valued at CN¥127.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥115.8m.

Having regard to Yueyang Xingchang Petro-Chemical's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥6.16b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Yueyang Xingchang Petro-Chemical also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Yueyang Xingchang Petro-Chemical grew its EBIT by 19% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Yueyang Xingchang Petro-Chemical 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 Yueyang Xingchang Petro-Chemical 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. Over the last three years, Yueyang Xingchang Petro-Chemical saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Yueyang Xingchang Petro-Chemical has CN¥237.7m in net cash. And it impressed us with its EBIT growth of 19% over the last year. So we are not troubled with Yueyang Xingchang Petro-Chemical'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. For example, we've discovered 2 warning signs for Yueyang Xingchang Petro-Chemical (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.