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. Importantly, Hunan Valin Wire & Cable Co.,Ltd. (SZSE:001208) does carry 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Hunan Valin Wire & CableLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Hunan Valin Wire & CableLtd had CN¥1.06b of debt, an increase on CN¥947.9m, over one year. On the flip side, it has CN¥627.4m in cash leading to net debt of about CN¥435.7m.

How Healthy Is Hunan Valin Wire & CableLtd's Balance Sheet?

We can see from the most recent balance sheet that Hunan Valin Wire & CableLtd had liabilities of CN¥2.57b falling due within a year, and liabilities of CN¥359.5m due beyond that. Offsetting this, it had CN¥627.4m in cash and CN¥1.95b in receivables that were due within 12 months. So it has liabilities totalling CN¥349.1m more than its cash and near-term receivables, combined.

Of course, Hunan Valin Wire & CableLtd has a market capitalization of CN¥4.63b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Hunan Valin Wire & CableLtd has a debt to EBITDA ratio of 2.6, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Importantly, Hunan Valin Wire & CableLtd grew its EBIT by 31% 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 it is Hunan Valin Wire & CableLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Hunan Valin Wire & CableLtd generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Hunan Valin Wire & CableLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Considering this range of factors, it seems to us that Hunan Valin Wire & CableLtd is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, 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 instance, we've identified 2 warning signs for Hunan Valin Wire & CableLtd (1 is significant) you should be aware of.

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.