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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Zhejiang Huace Film & TV Co., Ltd. (SZSE:300133) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Zhejiang Huace Film & TV Carry?

As you can see below, Zhejiang Huace Film & TV had CN¥700.6m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥5.04b in cash, leading to a CN¥4.34b net cash position.

How Healthy Is Zhejiang Huace Film & TV's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Huace Film & TV had liabilities of CN¥2.58b due within 12 months and liabilities of CN¥242.3m due beyond that. On the other hand, it had cash of CN¥5.04b and CN¥861.5m worth of receivables due within a year. So it actually has CN¥3.09b more liquid assets than total liabilities.

It's good to see that Zhejiang Huace Film & TV has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Zhejiang Huace Film & TV has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Zhejiang Huace Film & TV's load is not too heavy, because its EBIT was down 65% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Huace Film & TV can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhejiang Huace Film & TV 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. Happily for any shareholders, Zhejiang Huace Film & TV actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Huace Film & TV has CN¥4.34b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥72m, being 210% of its EBIT. So is Zhejiang Huace Film & TV's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Zhejiang Huace Film & TV 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.

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