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.' 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 Zhejiang Shibao Company Limited (HKG:1057) does have debt on its balance sheet. 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 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.

What Is Zhejiang Shibao's Debt?

As you can see below, Zhejiang Shibao had CN¥61.1m of debt at September 2024, down from CN¥168.1m a year prior. However, it does have CN¥407.2m in cash offsetting this, leading to net cash of CN¥346.1m.

How Healthy Is Zhejiang Shibao's Balance Sheet?

According to the last reported balance sheet, Zhejiang Shibao had liabilities of CN¥1.03b due within 12 months, and liabilities of CN¥30.5m due beyond 12 months. Offsetting this, it had CN¥407.2m in cash and CN¥1.06b in receivables that were due within 12 months. So it can boast CN¥404.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Shibao could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang Shibao has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Zhejiang Shibao grew its EBIT by 384% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Zhejiang Shibao 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. Zhejiang Shibao 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. During the last two years, Zhejiang Shibao burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Shibao has CN¥346.1m in net cash and a decent-looking balance sheet. And we liked the look of last year's 384% year-on-year EBIT growth. So we don't have any problem with Zhejiang Shibao's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Zhejiang Shibao , and understanding them should be part of your investment process.

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.