The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Zhejiang ZUCH Technology Co., Ltd (SZSE:301280) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Zhejiang ZUCH Technology Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Zhejiang ZUCH Technology had debt of CN¥53.9m, up from CN¥9.39m in one year. But it also has CN¥1.10b in cash to offset that, meaning it has CN¥1.05b net cash.

A Look At Zhejiang ZUCH Technology's Liabilities

We can see from the most recent balance sheet that Zhejiang ZUCH Technology had liabilities of CN¥575.5m falling due within a year, and liabilities of CN¥20.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.10b as well as receivables valued at CN¥727.0m due within 12 months. So it can boast CN¥1.24b more liquid assets than total liabilities.

This luscious liquidity implies that Zhejiang ZUCH Technology's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Zhejiang ZUCH Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Zhejiang ZUCH Technology grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang ZUCH Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang ZUCH Technology 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, Zhejiang ZUCH Technology actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang ZUCH Technology has CN¥1.05b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 21% over the last year. So is Zhejiang ZUCH Technology's debt a risk? It doesn't seem so to us. 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. Be aware that Zhejiang ZUCH Technology is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.