Warren Buffett famously said, '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. As with many other companies Shanghai Ziyan Foods Co., Ltd. (SHSE:603057) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shanghai Ziyan Foods's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Ziyan Foods had CN¥449.6m of debt, an increase on CN¥19.9m, over one year. However, it does have CN¥1.45b in cash offsetting this, leading to net cash of CN¥1.00b.

How Strong Is Shanghai Ziyan Foods' Balance Sheet?

According to the last reported balance sheet, Shanghai Ziyan Foods had liabilities of CN¥1.15b due within 12 months, and liabilities of CN¥238.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.45b as well as receivables valued at CN¥162.8m due within 12 months. So it actually has CN¥227.7m more liquid assets than total liabilities.

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

On the other hand, Shanghai Ziyan Foods's EBIT dived 19%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Ziyan Foods'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 Shanghai Ziyan Foods 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. Happily for any shareholders, Shanghai Ziyan Foods actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Ziyan Foods has net cash of CN¥1.00b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥232m, being 100% of its EBIT. So we don't have any problem with Shanghai Ziyan Foods's use of debt. 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 2 warning signs with Shanghai Ziyan Foods (at least 1 which is a bit concerning) , 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.