Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that WellCell Holdings Co., Limited (HKG:2477) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 WellCell Holdings's Debt?

The image below, which you can click on for greater detail, shows that WellCell Holdings had debt of CN¥21.1m at the end of June 2024, a reduction from CN¥32.1m over a year. However, its balance sheet shows it holds CN¥99.4m in cash, so it actually has CN¥78.3m net cash.

How Strong Is WellCell Holdings' Balance Sheet?

We can see from the most recent balance sheet that WellCell Holdings had liabilities of CN¥82.7m falling due within a year, and liabilities of CN¥1.31m due beyond that. On the other hand, it had cash of CN¥99.4m and CN¥151.3m worth of receivables due within a year. So it can boast CN¥166.7m more liquid assets than total liabilities.

This surplus suggests that WellCell Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, WellCell Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, WellCell Holdings grew its EBIT by 4.2% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since WellCell Holdings 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. WellCell Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, WellCell Holdings created free cash flow amounting to 4.1% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that WellCell Holdings has net cash of CN¥78.3m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 4.2% in the last twelve months. So we are not troubled with WellCell Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for WellCell Holdings you should be aware of, and 2 of them are significant.

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.