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, Chaozhou Three-Circle (Group) Co.,Ltd. (SZSE:300408) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Chaozhou Three-Circle (Group)Ltd Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Chaozhou Three-Circle (Group)Ltd had debt of CN¥681.0m, up from CN¥473.1m in one year. However, its balance sheet shows it holds CN¥6.89b in cash, so it actually has CN¥6.21b net cash.

How Healthy Is Chaozhou Three-Circle (Group)Ltd's Balance Sheet?

According to the last reported balance sheet, Chaozhou Three-Circle (Group)Ltd had liabilities of CN¥2.79b due within 12 months, and liabilities of CN¥1.28b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.89b as well as receivables valued at CN¥2.43b due within 12 months. So it can boast CN¥5.24b more liquid assets than total liabilities.

This surplus suggests that Chaozhou Three-Circle (Group)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Chaozhou Three-Circle (Group)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Chaozhou Three-Circle (Group)Ltd grew its EBIT by 66% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Chaozhou Three-Circle (Group)Ltd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Chaozhou Three-Circle (Group)Ltd 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. In the last three years, Chaozhou Three-Circle (Group)Ltd's free cash flow amounted to 49% of its EBIT, less 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 Chaozhou Three-Circle (Group)Ltd has CN¥6.21b in net cash and a decent-looking balance sheet. And we liked the look of last year's 66% year-on-year EBIT growth. So is Chaozhou Three-Circle (Group)Ltd's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Chaozhou Three-Circle (Group)Ltd you should know about.

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.