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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Ningbo Huaxiang Electronic Co., Ltd. (SZSE:002048) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Ningbo Huaxiang Electronic's Debt?

As you can see below, Ningbo Huaxiang Electronic had CN¥1.35b of debt at June 2024, down from CN¥1.41b a year prior. But it also has CN¥3.26b in cash to offset that, meaning it has CN¥1.90b net cash.

How Healthy Is Ningbo Huaxiang Electronic's Balance Sheet?

We can see from the most recent balance sheet that Ningbo Huaxiang Electronic had liabilities of CN¥10.4b falling due within a year, and liabilities of CN¥1.93b due beyond that. Offsetting these obligations, it had cash of CN¥3.26b as well as receivables valued at CN¥7.53b due within 12 months. So its liabilities total CN¥1.59b more than the combination of its cash and short-term receivables.

Given Ningbo Huaxiang Electronic has a market capitalization of CN¥9.82b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Ningbo Huaxiang Electronic boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Ningbo Huaxiang Electronic has increased its EBIT by 8.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ningbo Huaxiang Electronic'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ningbo Huaxiang Electronic 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, Ningbo Huaxiang Electronic recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Ningbo Huaxiang Electronic does have more liabilities than liquid assets, it also has net cash of CN¥1.90b. And it also grew its EBIT by 8.8% over the last year. So we don't have any problem with Ningbo Huaxiang Electronic's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Ningbo Huaxiang Electronic .

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.