Warren Buffett famously said, '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 Chongqing VDL Electronics Co., Ltd. (SZSE:301121) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

How Much Debt Does Chongqing VDL Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Chongqing VDL Electronics had debt of CN¥577.0m, up from CN¥427.5m in one year. However, its balance sheet shows it holds CN¥852.2m in cash, so it actually has CN¥275.2m net cash.

How Strong Is Chongqing VDL Electronics' Balance Sheet?

According to the last reported balance sheet, Chongqing VDL Electronics had liabilities of CN¥890.6m due within 12 months, and liabilities of CN¥88.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥852.2m as well as receivables valued at CN¥414.3m due within 12 months. So it can boast CN¥287.5m more liquid assets than total liabilities.

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

It was also good to see that despite losing money on the EBIT line last year, Chongqing VDL Electronics turned things around in the last 12 months, delivering and EBIT of CN¥52m. 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 Chongqing VDL Electronics will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Chongqing VDL Electronics 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. Over the last year, Chongqing VDL Electronics saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chongqing VDL Electronics has CN¥275.2m in net cash and a decent-looking balance sheet. So we are not troubled with Chongqing VDL Electronics's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Chongqing VDL Electronics (1 is concerning) you should be aware of.

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.