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.' 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. We note that Foshan Haitian Flavouring and Food Company Ltd. (SHSE:603288) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Foshan Haitian Flavouring and Food's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Foshan Haitian Flavouring and Food had debt of CN¥683.1m, up from CN¥240.8m in one year. But it also has CN¥26.9b in cash to offset that, meaning it has CN¥26.2b net cash.

A Look At Foshan Haitian Flavouring and Food's Liabilities

We can see from the most recent balance sheet that Foshan Haitian Flavouring and Food had liabilities of CN¥5.85b falling due within a year, and liabilities of CN¥447.2m due beyond that. Offsetting this, it had CN¥26.9b in cash and CN¥264.1m in receivables that were due within 12 months. So it can boast CN¥20.8b more liquid assets than total liabilities.

This surplus suggests that Foshan Haitian Flavouring and Food has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Foshan Haitian Flavouring and Food has more cash than debt is arguably a good indication that it can manage its debt safely.

While Foshan Haitian Flavouring and Food doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Foshan Haitian Flavouring and Food's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Foshan Haitian Flavouring and Food 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. Over the most recent three years, Foshan Haitian Flavouring and Food recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Foshan Haitian Flavouring and Food has net cash of CN¥26.2b, as well as more liquid assets than liabilities. So we don't think Foshan Haitian Flavouring and Food's use of debt is risky. 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 2 warning signs for Foshan Haitian Flavouring and Food (1 is a bit unpleasant!) 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.