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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Yangzijiang Shipbuilding (Holdings) Ltd. (SGX:BS6) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Yangzijiang Shipbuilding (Holdings)

What Is Yangzijiang Shipbuilding (Holdings)'s Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Yangzijiang Shipbuilding (Holdings) had debt of CN¥5.33b, up from CN¥4.68b in one year. But it also has CN¥11.4b in cash to offset that, meaning it has CN¥6.07b net cash.

How Healthy Is Yangzijiang Shipbuilding (Holdings)'s Balance Sheet?

The latest balance sheet data shows that Yangzijiang Shipbuilding (Holdings) had liabilities of CN¥12.6b due within a year, and liabilities of CN¥2.32b falling due after that. On the other hand, it had cash of CN¥11.4b and CN¥8.48b worth of receivables due within a year. So it actually has CN¥4.98b more liquid assets than total liabilities.

It's good to see that Yangzijiang Shipbuilding (Holdings) has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. 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 Yangzijiang Shipbuilding (Holdings) 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 Yangzijiang Shipbuilding (Holdings) has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 Yangzijiang Shipbuilding (Holdings)'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. Yangzijiang Shipbuilding (Holdings) 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 last three years, Yangzijiang Shipbuilding (Holdings) actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Yangzijiang Shipbuilding (Holdings) has net cash of CN¥6.07b, as well as more liquid assets than liabilities. The cherry on top was that in converted 126% of that EBIT to free cash flow, bringing in CN¥3.4b. The bottom line is that we do not find Yangzijiang Shipbuilding (Holdings)'s debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yangzijiang Shipbuilding (Holdings) you should know about.

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.