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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Jiangxi Chenguang New Materials Company Limited (SHSE:605399) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Jiangxi Chenguang New Materials's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Jiangxi Chenguang New Materials had debt of CN¥39.0m, up from none in one year. But it also has CN¥1.25b in cash to offset that, meaning it has CN¥1.21b net cash.

How Healthy Is Jiangxi Chenguang New Materials' Balance Sheet?

According to the last reported balance sheet, Jiangxi Chenguang New Materials had liabilities of CN¥477.3m due within 12 months, and liabilities of CN¥123.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.25b as well as receivables valued at CN¥187.9m due within 12 months. So it can boast CN¥836.5m more liquid assets than total liabilities.

This excess liquidity suggests that Jiangxi Chenguang New Materials is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Jiangxi Chenguang New Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Jiangxi Chenguang New Materials's load is not too heavy, because its EBIT was down 93% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Jiangxi Chenguang New Materials's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Jiangxi Chenguang New Materials 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 most recent three years, Jiangxi Chenguang New Materials recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangxi Chenguang New Materials has CN¥1.21b in net cash and a decent-looking balance sheet. So we are not troubled with Jiangxi Chenguang New Materials's debt use. 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. For instance, we've identified 4 warning signs for Jiangxi Chenguang New Materials (1 is a bit unpleasant) you should be aware of.

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.

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.