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. We can see that ZTE Corporation (SZSE:000063) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does ZTE Carry?

As you can see below, at the end of December 2023, ZTE had CN¥56.8b of debt, up from CN¥45.6b a year ago. Click the image for more detail. But it also has CN¥78.7b in cash to offset that, meaning it has CN¥21.9b net cash.

A Look At ZTE's Liabilities

We can see from the most recent balance sheet that ZTE had liabilities of CN¥83.0b falling due within a year, and liabilities of CN¥49.6b due beyond that. On the other hand, it had cash of CN¥78.7b and CN¥30.9b worth of receivables due within a year. So it has liabilities totalling CN¥23.0b more than its cash and near-term receivables, combined.

Since publicly traded ZTE shares are worth a very impressive total of CN¥123.6b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, ZTE also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, ZTE grew its EBIT by 5.5% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if ZTE 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While ZTE 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, ZTE generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While ZTE does have more liabilities than liquid assets, it also has net cash of CN¥21.9b. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in CN¥13b. So we don't think ZTE's use of debt is risky. 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. For example, we've discovered 1 warning sign for ZTE that you should be aware of before investing here.

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.