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 Zhewen Interactive Group Co., Ltd. (SHSE:600986) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Zhewen Interactive Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhewen Interactive Group had CN¥888.8m of debt in September 2023, down from CN¥1.20b, one year before. However, its balance sheet shows it holds CN¥1.06b in cash, so it actually has CN¥169.5m net cash.

A Look At Zhewen Interactive Group's Liabilities

The latest balance sheet data shows that Zhewen Interactive Group had liabilities of CN¥3.28b due within a year, and liabilities of CN¥34.6m falling due after that. Offsetting these obligations, it had cash of CN¥1.06b as well as receivables valued at CN¥4.71b due within 12 months. So it actually has CN¥2.45b more liquid assets than total liabilities.

This surplus strongly suggests that Zhewen Interactive Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Zhewen Interactive Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Zhewen Interactive Group's saving grace is its low debt levels, because its EBIT has tanked 63% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhewen Interactive 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 Zhewen Interactive 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. During the last three years, Zhewen Interactive Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhewen Interactive Group has CN¥169.5m in net cash and a decent-looking balance sheet. So we don't have any problem with Zhewen Interactive Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Zhewen Interactive Group , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.