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 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 Sichuan Meifeng Chemical Industry Co., Ltd. (SZSE:000731) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Sichuan Meifeng Chemical Industry Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Sichuan Meifeng Chemical Industry had CN¥262.0m of debt, an increase on CN¥203.4m, over one year. But on the other hand it also has CN¥2.55b in cash, leading to a CN¥2.29b net cash position.

How Healthy Is Sichuan Meifeng Chemical Industry's Balance Sheet?

According to the last reported balance sheet, Sichuan Meifeng Chemical Industry had liabilities of CN¥1.16b due within 12 months, and liabilities of CN¥286.2m due beyond 12 months. Offsetting this, it had CN¥2.55b in cash and CN¥229.1m in receivables that were due within 12 months. So it can boast CN¥1.33b more liquid assets than total liabilities.

This excess liquidity is a great indication that Sichuan Meifeng Chemical Industry's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Sichuan Meifeng Chemical Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Sichuan Meifeng Chemical Industry's saving grace is its low debt levels, because its EBIT has tanked 41% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sichuan Meifeng Chemical Industry 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sichuan Meifeng Chemical Industry 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. During the last three years, Sichuan Meifeng Chemical Industry generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Meifeng Chemical Industry has net cash of CN¥2.29b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥472m, being 91% of its EBIT. So we don't think Sichuan Meifeng Chemical Industry's use of debt is risky. 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 Sichuan Meifeng Chemical Industry .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.