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 Zhefu Holding Group Co., Ltd. (SZSE:002266) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zhefu Holding Group's Net Debt?

The image below, which you can click on for greater detail, shows that Zhefu Holding Group had debt of CN¥4.32b at the end of September 2024, a reduction from CN¥5.67b over a year. But on the other hand it also has CN¥4.78b in cash, leading to a CN¥453.2m net cash position.

A Look At Zhefu Holding Group's Liabilities

The latest balance sheet data shows that Zhefu Holding Group had liabilities of CN¥12.6b due within a year, and liabilities of CN¥944.1m falling due after that. Offsetting these obligations, it had cash of CN¥4.78b as well as receivables valued at CN¥1.84b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.96b.

Zhefu Holding Group has a market capitalization of CN¥17.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Zhefu Holding Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Zhefu Holding Group if management cannot prevent a repeat of the 63% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Zhefu Holding Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zhefu Holding Group 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. Considering the last three years, Zhefu Holding Group actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

Although Zhefu Holding Group'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¥453.2m. So while Zhefu Holding Group does not have a great balance sheet, it's certainly not too bad. 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. We've identified 3 warning signs with Zhefu Holding Group , 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.