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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Hangcha Group Co., Ltd (SHSE:603298) makes use of 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Hangcha Group Carry?

As you can see below, at the end of March 2024, Hangcha Group had CN¥929.4m of debt, up from CN¥873.1m a year ago. Click the image for more detail. However, it does have CN¥3.99b in cash offsetting this, leading to net cash of CN¥3.06b.

How Strong Is Hangcha Group's Balance Sheet?

According to the last reported balance sheet, Hangcha Group had liabilities of CN¥5.45b due within 12 months, and liabilities of CN¥138.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.99b as well as receivables valued at CN¥2.94b due within 12 months. So it actually has CN¥1.34b more liquid assets than total liabilities.

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

On top of that, Hangcha Group grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hangcha Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hangcha Group 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, Hangcha Group recorded free cash flow of 25% 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 Hangcha Group has net cash of CN¥3.06b, as well as more liquid assets than liabilities. And we liked the look of last year's 54% year-on-year EBIT growth. So is Hangcha Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Hangcha Group .

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.

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