David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Want Want China Holdings Limited (HKG:151) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Want Want China Holdings

What Is Want Want China Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Want Want China Holdings had debt of CN¥6.90b at the end of March 2022, a reduction from CN¥9.83b over a year. However, its balance sheet shows it holds CN¥11.3b in cash, so it actually has CN¥4.39b net cash.

How Strong Is Want Want China Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Want Want China Holdings had liabilities of CN¥9.25b due within 12 months and liabilities of CN¥3.90b due beyond that. Offsetting this, it had CN¥11.3b in cash and CN¥1.38b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥482.0m.

Having regard to Want Want China Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥65.2b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Want Want China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Want Want China Holdings saw its EBIT decline by 2.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Want Want China Holdings can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Want Want China Holdings 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. During the last three years, Want Want China Holdings generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Want Want China Holdings has CN¥4.39b in net cash. The cherry on top was that in converted 85% of that EBIT to free cash flow, bringing in CN¥3.5b. So is Want Want China Holdings'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. Be aware that Want Want China Holdings is showing 1 warning sign in our investment analysis , you should know about...

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.