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.' 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. Importantly, Chaozhou Three-Circle (Group) Co.,Ltd. (SZSE:300408) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Chaozhou Three-Circle (Group)Ltd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Chaozhou Three-Circle (Group)Ltd had debt of CN¥878.6m, up from CN¥103.6m in one year. However, it does have CN¥6.85b in cash offsetting this, leading to net cash of CN¥5.97b.

A Look At Chaozhou Three-Circle (Group)Ltd's Liabilities

We can see from the most recent balance sheet that Chaozhou Three-Circle (Group)Ltd had liabilities of CN¥2.36b falling due within a year, and liabilities of CN¥1.27b due beyond that. Offsetting these obligations, it had cash of CN¥6.85b as well as receivables valued at CN¥2.34b due within 12 months. So it can boast CN¥5.55b more liquid assets than total liabilities.

This surplus suggests that Chaozhou Three-Circle (Group)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Chaozhou Three-Circle (Group)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Chaozhou Three-Circle (Group)Ltd grew its EBIT by 35% over the last twelve months, and that growth will make it easier to handle its debt. 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 Chaozhou Three-Circle (Group)Ltd 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 company can only pay off debt with cold hard cash, not accounting profits. While Chaozhou Three-Circle (Group)Ltd 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, Chaozhou Three-Circle (Group)Ltd recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Chaozhou Three-Circle (Group)Ltd has net cash of CN¥5.97b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 35% over the last year. So we don't think Chaozhou Three-Circle (Group)Ltd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Chaozhou Three-Circle (Group)Ltd , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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