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 note that Yinbang Clad Material Co.,Ltd (SZSE:300337) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Yinbang Clad MaterialLtd's Debt?

As you can see below, Yinbang Clad MaterialLtd had CN¥2.25b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CN¥200.3m in cash, and so its net debt is CN¥2.05b.

A Look At Yinbang Clad MaterialLtd's Liabilities

According to the last reported balance sheet, Yinbang Clad MaterialLtd had liabilities of CN¥747.7m due within 12 months, and liabilities of CN¥2.11b due beyond 12 months. On the other hand, it had cash of CN¥200.3m and CN¥1.06b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.60b.

While this might seem like a lot, it is not so bad since Yinbang Clad MaterialLtd has a market capitalization of CN¥6.02b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Yinbang Clad MaterialLtd shareholders face the double whammy of a high net debt to EBITDA ratio (7.2), and fairly weak interest coverage, since EBIT is just 2.1 times the interest expense. This means we'd consider it to have a heavy debt load. The good news is that Yinbang Clad MaterialLtd grew its EBIT a smooth 65% over the last twelve months. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Yinbang Clad MaterialLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Yinbang Clad MaterialLtd saw substantial negative free cash flow, in total. 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.

Our View

Yinbang Clad MaterialLtd's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. Taking the abovementioned factors together we do think Yinbang Clad MaterialLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. For example Yinbang Clad MaterialLtd has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

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.