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 Zhejiang Hailide New Material Co.,Ltd (SZSE:002206) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhejiang Hailide New MaterialLtd

How Much Debt Does Zhejiang Hailide New MaterialLtd Carry?

As you can see below, at the end of March 2022, Zhejiang Hailide New MaterialLtd had CN¥2.88b of debt, up from CN¥2.12b a year ago. Click the image for more detail. On the flip side, it has CN¥1.31b in cash leading to net debt of about CN¥1.57b.

How Healthy Is Zhejiang Hailide New MaterialLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Hailide New MaterialLtd had liabilities of CN¥3.46b falling due within a year, and liabilities of CN¥741.5m due beyond that. Offsetting this, it had CN¥1.31b in cash and CN¥1.12b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.77b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Zhejiang Hailide New MaterialLtd has a market capitalization of CN¥7.44b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zhejiang Hailide New MaterialLtd's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its commanding EBIT of 47.2 times its interest expense, implies the debt load is as light as a peacock feather. On top of that, Zhejiang Hailide New MaterialLtd grew its EBIT by 80% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhejiang Hailide New MaterialLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Zhejiang Hailide New MaterialLtd 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.

Our View

Zhejiang Hailide New MaterialLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Zhejiang Hailide New MaterialLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Zhejiang Hailide New MaterialLtd (including 1 which can't be ignored) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.