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 Quechen Silicon Chemical Co., Ltd. (SHSE:605183) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Quechen Silicon Chemical Carry?

As you can see below, at the end of March 2024, Quechen Silicon Chemical had CN¥61.6m of debt, up from CN¥50.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥730.0m in cash, so it actually has CN¥668.4m net cash.

How Healthy Is Quechen Silicon Chemical's Balance Sheet?

The latest balance sheet data shows that Quechen Silicon Chemical had liabilities of CN¥405.5m due within a year, and liabilities of CN¥221.3k falling due after that. Offsetting this, it had CN¥730.0m in cash and CN¥679.0m in receivables that were due within 12 months. So it can boast CN¥1.00b more liquid assets than total liabilities.

This surplus suggests that Quechen Silicon Chemical has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Quechen Silicon Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Quechen Silicon Chemical grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Quechen Silicon Chemical can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Quechen Silicon 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. Looking at the most recent three years, Quechen Silicon Chemical recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Quechen Silicon Chemical has CN¥668.4m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 26% over the last year. So is Quechen Silicon Chemical's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Quechen Silicon Chemical you should be aware of.

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.