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 can see that Ningbo Yongxin Optics Co., Ltd. (SHSE:603297) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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 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 Ningbo Yongxin Optics

What Is Ningbo Yongxin Optics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ningbo Yongxin Optics had CN¥25.0m of debt in March 2022, down from CN¥57.8m, one year before. However, its balance sheet shows it holds CN¥864.4m in cash, so it actually has CN¥839.3m net cash.

How Healthy Is Ningbo Yongxin Optics' Balance Sheet?

The latest balance sheet data shows that Ningbo Yongxin Optics had liabilities of CN¥178.2m due within a year, and liabilities of CN¥13.3m falling due after that. Offsetting this, it had CN¥864.4m in cash and CN¥190.9m in receivables that were due within 12 months. So it actually has CN¥863.8m more liquid assets than total liabilities.

This surplus suggests that Ningbo Yongxin Optics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ningbo Yongxin Optics has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Ningbo Yongxin Optics grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ningbo Yongxin Optics's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. Ningbo Yongxin Optics 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, Ningbo Yongxin Optics produced sturdy free cash flow equating to 58% 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 we empathize with investors who find debt concerning, you should keep in mind that Ningbo Yongxin Optics has net cash of CN¥839.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 33% year-on-year EBIT growth. So is Ningbo Yongxin Optics'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. To that end, you should be aware of the 3 warning signs we've spotted with Ningbo Yongxin Optics .

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.