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.' 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. We note that China YuHua Education Corporation Limited (HKG:6169) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for China YuHua Education

How Much Debt Does China YuHua Education Carry?

The image below, which you can click on for greater detail, shows that China YuHua Education had debt of CN¥2.31b at the end of February 2022, a reduction from CN¥2.85b over a year. But on the other hand it also has CN¥3.00b in cash, leading to a CN¥687.2m net cash position.

A Look At China YuHua Education's Liabilities

Zooming in on the latest balance sheet data, we can see that China YuHua Education had liabilities of CN¥4.02b due within 12 months and liabilities of CN¥1.17b due beyond that. Offsetting these obligations, it had cash of CN¥3.00b as well as receivables valued at CN¥88.7m due within 12 months. So it has liabilities totalling CN¥2.10b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥2.93b, so it does suggest shareholders should keep an eye on China YuHua Education's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, China YuHua Education boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, China YuHua Education grew its EBIT by 26% in the last year, and that should make it 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 YuHua Education'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While China YuHua Education 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. Happily for any shareholders, China YuHua Education actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

Although China YuHua Education's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥687.2m. And it impressed us with free cash flow of CN¥1.6b, being 124% of its EBIT. So we don't think China YuHua Education's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for China YuHua Education that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.