Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Shanghai Foreign Service Holding Group Co., Ltd. (SHSE:600662) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shanghai Foreign Service Holding Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shanghai Foreign Service Holding Group had CN¥805.7m of debt in September 2024, down from CN¥1.00b, one year before. However, it does have CN¥9.20b in cash offsetting this, leading to net cash of CN¥8.39b.

A Look At Shanghai Foreign Service Holding Group's Liabilities

The latest balance sheet data shows that Shanghai Foreign Service Holding Group had liabilities of CN¥10.2b due within a year, and liabilities of CN¥137.1m falling due after that. On the other hand, it had cash of CN¥9.20b and CN¥2.71b worth of receivables due within a year. So it can boast CN¥1.59b more liquid assets than total liabilities.

This surplus suggests that Shanghai Foreign Service Holding Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Foreign Service Holding Group has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that Shanghai Foreign Service Holding Group saw its EBIT decline by 4.9% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Foreign Service Holding Group can strengthen its balance sheet over time. 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 Foreign Service 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. Over the most recent three years, Shanghai Foreign Service Holding Group recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Foreign Service Holding Group has net cash of CN¥8.39b, as well as more liquid assets than liabilities. So is Shanghai Foreign Service Holding Group's debt a risk? It doesn't seem so to us. 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 Shanghai Foreign Service 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.