Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Namchow Food Group (Shanghai) Co., Ltd. (SHSE:605339) 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

What Is Namchow Food Group (Shanghai)'s Debt?

The image below, which you can click on for greater detail, shows that Namchow Food Group (Shanghai) had debt of CN¥235.8m at the end of December 2023, a reduction from CN¥348.3m over a year. But on the other hand it also has CN¥1.70b in cash, leading to a CN¥1.47b net cash position.

How Strong Is Namchow Food Group (Shanghai)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Namchow Food Group (Shanghai) had liabilities of CN¥682.1m due within 12 months and liabilities of CN¥65.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.70b as well as receivables valued at CN¥184.3m due within 12 months. So it actually has CN¥1.14b more liquid assets than total liabilities.

This excess liquidity suggests that Namchow Food Group (Shanghai) is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Namchow Food Group (Shanghai) has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Namchow Food Group (Shanghai) has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. 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 Namchow Food Group (Shanghai) 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Namchow Food Group (Shanghai) 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. During the last three years, Namchow Food Group (Shanghai) produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. 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 Namchow Food Group (Shanghai) has CN¥1.47b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 48% over the last year. So we don't think Namchow Food Group (Shanghai)'s use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Namchow Food Group (Shanghai) 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.

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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.