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 Zhuhai Enpower Electric Co.,Ltd. (SZSE:300681) makes use of debt. But the more important question is: how much risk is that debt creating?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Zhuhai Enpower ElectricLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Zhuhai Enpower ElectricLtd had CN¥781.5m of debt in September 2024, down from CN¥1.04b, one year before. However, it does have CN¥840.3m in cash offsetting this, leading to net cash of CN¥58.8m.

How Healthy Is Zhuhai Enpower ElectricLtd's Balance Sheet?

According to the last reported balance sheet, Zhuhai Enpower ElectricLtd had liabilities of CN¥1.90b due within 12 months, and liabilities of CN¥708.0m due beyond 12 months. Offsetting this, it had CN¥840.3m in cash and CN¥752.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.02b more than its cash and near-term receivables, combined.

Since publicly traded Zhuhai Enpower ElectricLtd shares are worth a total of CN¥5.99b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Zhuhai Enpower ElectricLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although Zhuhai Enpower ElectricLtd made a loss at the EBIT level, last year, it was also good to see that it generated CN¥28m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhuhai Enpower ElectricLtd 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. Zhuhai Enpower ElectricLtd 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. Looking at the most recent year, Zhuhai Enpower ElectricLtd recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Zhuhai Enpower ElectricLtd'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¥58.8m. So we don't have any problem with Zhuhai Enpower ElectricLtd'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. For instance, we've identified 2 warning signs for Zhuhai Enpower ElectricLtd that you should be aware of.

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.