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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Xinxiang Richful Lube Additive Co.,Ltd. (SZSE:300910) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Xinxiang Richful Lube AdditiveLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Xinxiang Richful Lube AdditiveLtd had CN¥305.9m of debt, an increase on CN¥68.6m, over one year. But it also has CN¥1.22b in cash to offset that, meaning it has CN¥915.4m net cash.

How Strong Is Xinxiang Richful Lube AdditiveLtd's Balance Sheet?

The latest balance sheet data shows that Xinxiang Richful Lube AdditiveLtd had liabilities of CN¥686.7m due within a year, and liabilities of CN¥163.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥560.7m due within 12 months. So it actually has CN¥932.2m more liquid assets than total liabilities.

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

While Xinxiang Richful Lube AdditiveLtd doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Xinxiang Richful Lube AdditiveLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Xinxiang Richful Lube AdditiveLtd 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, Xinxiang Richful Lube AdditiveLtd's free cash flow amounted to 31% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xinxiang Richful Lube AdditiveLtd has net cash of CN¥915.4m, as well as more liquid assets than liabilities. So we are not troubled with Xinxiang Richful Lube AdditiveLtd'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. We've identified 2 warning signs with Xinxiang Richful Lube AdditiveLtd (at least 1 which is significant) , and understanding them should be part of your investment process.

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.