Warren Buffett famously said, '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. We note that Zhejiang Feida Environmental Science & Technology Co., Ltd. (SHSE:600526) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Zhejiang Feida Environmental Science & Technology Carry?

As you can see below, at the end of June 2024, Zhejiang Feida Environmental Science & Technology had CN¥4.35b of debt, up from CN¥2.25b a year ago. Click the image for more detail. However, it does have CN¥1.89b in cash offsetting this, leading to net debt of about CN¥2.46b.

A Look At Zhejiang Feida Environmental Science & Technology's Liabilities

We can see from the most recent balance sheet that Zhejiang Feida Environmental Science & Technology had liabilities of CN¥4.62b falling due within a year, and liabilities of CN¥1.32b due beyond that. Offsetting these obligations, it had cash of CN¥1.89b as well as receivables valued at CN¥3.78b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥269.8m.

Given Zhejiang Feida Environmental Science & Technology has a market capitalization of CN¥3.96b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhejiang Feida Environmental Science & Technology has a debt to EBITDA ratio of 4.4, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 17.9 is very high, suggesting that the interest expense on the debt is currently quite low. We saw Zhejiang Feida Environmental Science & Technology grow its EBIT by 6.7% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zhejiang Feida Environmental Science & Technology will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Zhejiang Feida Environmental Science & Technology actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Zhejiang Feida Environmental Science & Technology's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. When we consider the range of factors above, it looks like Zhejiang Feida Environmental Science & Technology is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Zhejiang Feida Environmental Science & Technology , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.