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. Importantly, Wuxi Double Elephant Micro Fibre Material Co.,Ltd (SZSE:002395) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Wuxi Double Elephant Micro Fibre MaterialLtd Carry?

The image below, which you can click on for greater detail, shows that Wuxi Double Elephant Micro Fibre MaterialLtd had debt of CN¥114.8m at the end of June 2024, a reduction from CN¥125.5m over a year. But on the other hand it also has CN¥236.5m in cash, leading to a CN¥121.6m net cash position.

How Strong Is Wuxi Double Elephant Micro Fibre MaterialLtd's Balance Sheet?

According to the last reported balance sheet, Wuxi Double Elephant Micro Fibre MaterialLtd had liabilities of CN¥775.0m due within 12 months, and liabilities of CN¥632.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥236.5m as well as receivables valued at CN¥410.5m due within 12 months. So its liabilities total CN¥760.3m more than the combination of its cash and short-term receivables.

Of course, Wuxi Double Elephant Micro Fibre MaterialLtd has a market capitalization of CN¥4.11b, 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. While it does have liabilities worth noting, Wuxi Double Elephant Micro Fibre MaterialLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Wuxi Double Elephant Micro Fibre MaterialLtd made a loss at the EBIT level, last year, it was also good to see that it generated CN¥61m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Wuxi Double Elephant Micro Fibre MaterialLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Wuxi Double Elephant Micro Fibre MaterialLtd 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 year, Wuxi Double Elephant Micro Fibre MaterialLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

Although Wuxi Double Elephant Micro Fibre MaterialLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥121.6m. So we don't have any problem with Wuxi Double Elephant Micro Fibre MaterialLtd'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. Be aware that Wuxi Double Elephant Micro Fibre MaterialLtd is showing 3 warning signs in our investment analysis , and 2 of those are potentially serious...

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.