Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Zhejiang Dahua Technology Co., Ltd. (SZSE:002236) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhejiang Dahua Technology Carry?

As you can see below, Zhejiang Dahua Technology had CN¥1.33b of debt at March 2024, down from CN¥3.68b a year prior. But on the other hand it also has CN¥14.2b in cash, leading to a CN¥12.9b net cash position.

How Healthy Is Zhejiang Dahua Technology's Balance Sheet?

The latest balance sheet data shows that Zhejiang Dahua Technology had liabilities of CN¥12.8b due within a year, and liabilities of CN¥636.8m falling due after that. On the other hand, it had cash of CN¥14.2b and CN¥17.4b worth of receivables due within a year. So it actually has CN¥18.1b more liquid assets than total liabilities.

This surplus strongly suggests that Zhejiang Dahua Technology has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Zhejiang Dahua Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Zhejiang Dahua Technology grew its EBIT by 137% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Dahua Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhejiang Dahua Technology may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, Zhejiang Dahua Technology recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Dahua Technology has net cash of CN¥12.9b, as well as more liquid assets than liabilities. And we liked the look of last year's 137% year-on-year EBIT growth. So is Zhejiang Dahua Technology'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. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Zhejiang Dahua Technology (1 is significant!) that you should be aware of before investing here.

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