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. We note that Xtep International Holdings Limited (HKG:1368) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Xtep International Holdings's Debt?

The image below, which you can click on for greater detail, shows that Xtep International Holdings had debt of CN¥3.03b at the end of June 2024, a reduction from CN¥3.27b over a year. However, it does have CN¥3.86b in cash offsetting this, leading to net cash of CN¥833.6m.

A Look At Xtep International Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Xtep International Holdings had liabilities of CN¥6.20b due within 12 months and liabilities of CN¥1.89b due beyond that. Offsetting these obligations, it had cash of CN¥3.86b as well as receivables valued at CN¥4.84b due within 12 months. So it can boast CN¥608.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Xtep International Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Xtep International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Xtep International Holdings grew its EBIT at 12% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Xtep International Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Xtep International Holdings 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. Looking at the most recent three years, Xtep International Holdings recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xtep International Holdings has CN¥833.6m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 12% in the last twelve months. So we are not troubled with Xtep International Holdings's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Xtep International Holdings has 1 warning sign we think 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.