Warren Buffett famously said, '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 can see that Anker Innovations Limited (SZSE:300866) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Anker Innovations's Net Debt?

As you can see below, at the end of March 2024, Anker Innovations had CN¥1.19b of debt, up from CN¥933.3m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.98b in cash, so it actually has CN¥2.79b net cash.

A Look At Anker Innovations' Liabilities

We can see from the most recent balance sheet that Anker Innovations had liabilities of CN¥3.41b falling due within a year, and liabilities of CN¥1.38b due beyond that. Offsetting these obligations, it had cash of CN¥3.98b as well as receivables valued at CN¥1.48b due within 12 months. So it can boast CN¥665.2m more liquid assets than total liabilities.

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

On top of that, Anker Innovations grew its EBIT by 64% 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 it is future earnings, more than anything, that will determine Anker Innovations'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Anker Innovations 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. During the last three years, Anker Innovations produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Anker Innovations has net cash of CN¥2.79b, as well as more liquid assets than liabilities. And we liked the look of last year's 64% year-on-year EBIT growth. So is Anker Innovations'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. For example, we've discovered 1 warning sign for Anker Innovations 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.