Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, China XD Electric Co., Ltd (SHSE:601179) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is China XD Electric's Debt?

As you can see below, China XD Electric had CN¥680.3m of debt at September 2024, down from CN¥1.84b a year prior. But it also has CN¥9.48b in cash to offset that, meaning it has CN¥8.80b net cash.

How Healthy Is China XD Electric's Balance Sheet?

According to the last reported balance sheet, China XD Electric had liabilities of CN¥19.2b due within 12 months, and liabilities of CN¥1.71b due beyond 12 months. Offsetting this, it had CN¥9.48b in cash and CN¥14.6b in receivables that were due within 12 months. So it can boast CN¥3.19b more liquid assets than total liabilities.

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

Better yet, China XD Electric grew its EBIT by 152% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 China XD Electric'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. China XD Electric 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 three years, China XD Electric actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case China XD Electric has CN¥8.80b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.6b, being 112% of its EBIT. So we don't think China XD Electric's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for China XD Electric you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.