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.'  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 $DONGYUE GROUP (00189.HK)$ makes use of debt.  But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy.  If things get really bad, the lenders can take control of the business.  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.  Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage.  When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Dongyue Group

What Is Dongyue Group's Net Debt?

As you can see below, Dongyue Group had CN¥670.6m of debt at June 2022, down from CN¥2.00b a year prior.    But it also has CN¥5.91b in cash to offset that, meaning it has CN¥5.24b net cash.

SEHK:189 Debt to Equity History August 28th 2022

How Strong Is Dongyue Group's Balance Sheet?

According to the last reported balance sheet, Dongyue Group had liabilities of CN¥6.26b due within 12 months, and liabilities of CN¥870.7m due beyond 12 months.   Offsetting these obligations, it had cash of CN¥5.91b as well as receivables valued at CN¥2.65b due within 12 months.   So it can boast CN¥1.43b more liquid assets than total liabilities.

This surplus suggests that Dongyue Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty.     Succinctly put, Dongyue Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Dongyue Group grew its EBIT by 229% over twelve months.  If maintained that growth will make the debt even more manageable in the years ahead.      When analysing debt levels, the balance sheet is the obvious place to start.  But ultimately the future profitability of the business will decide if Dongyue Group can strengthen its balance sheet over time.  So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash.   While Dongyue Group 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.    In the last three years, Dongyue Group created free cash flow amounting to 9.9% of its EBIT, an uninspiring performance.  For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Dongyue Group has net cash of CN¥5.24b, as well as more liquid assets than liabilities.     And we liked the look of last year's 229% year-on-year EBIT growth.     So we don't think Dongyue Group'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.   To that end, you should learn about the   3 warning signs we've spotted with Dongyue Group (including 1 which is significant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.