David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Jiangsu Zhengdan Chemical Industry Co., Ltd. (SZSE:300641) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Jiangsu Zhengdan Chemical Industry's Debt?

You can click the graphic below for the historical numbers, but it shows that Jiangsu Zhengdan Chemical Industry had CN¥457.5m of debt in March 2024, down from CN¥548.9m, one year before. But it also has CN¥592.6m in cash to offset that, meaning it has CN¥135.1m net cash.

How Healthy Is Jiangsu Zhengdan Chemical Industry's Balance Sheet?

According to the last reported balance sheet, Jiangsu Zhengdan Chemical Industry had liabilities of CN¥331.4m due within 12 months, and liabilities of CN¥326.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥592.6m as well as receivables valued at CN¥481.1m due within 12 months. So it can boast CN¥416.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangsu Zhengdan Chemical Industry could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Jiangsu Zhengdan Chemical Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Jiangsu Zhengdan Chemical Industry grew its EBIT by 48% 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 you can't view debt in total isolation; since Jiangsu Zhengdan Chemical Industry 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Jiangsu Zhengdan Chemical Industry 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. In the last three years, Jiangsu Zhengdan Chemical Industry created free cash flow amounting to 12% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangsu Zhengdan Chemical Industry has CN¥135.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 48% over the last year. So we don't think Jiangsu Zhengdan Chemical Industry's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Jiangsu Zhengdan Chemical Industry you should be aware of, and 1 of them makes us a bit uncomfortable.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com