Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Hangzhou Huawang New Material Technology Co.,Ltd. (SHSE:605377) does use debt in its business. But the more important question is: how much risk is that debt creating?

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Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hangzhou Huawang New Material TechnologyLtd's Net Debt?

As you can see below, at the end of December 2024, Hangzhou Huawang New Material TechnologyLtd had CN¥618.4m of debt, up from CN¥370.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.40b in cash, so it actually has CN¥1.78b net cash.

How Healthy Is Hangzhou Huawang New Material TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Hangzhou Huawang New Material TechnologyLtd had liabilities of CN¥2.06b due within a year, and liabilities of CN¥75.7m falling due after that. Offsetting this, it had CN¥2.40b in cash and CN¥1.34b in receivables that were due within 12 months. So it can boast CN¥1.61b more liquid assets than total liabilities.

This excess liquidity is a great indication that Hangzhou Huawang New Material TechnologyLtd's balance sheet is almost as strong as Fort Knox. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Hangzhou Huawang New Material TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hangzhou Huawang New Material TechnologyLtd's EBIT dived 13%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hangzhou Huawang New Material TechnologyLtd 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 Hangzhou Huawang New Material TechnologyLtd 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, Hangzhou Huawang New Material TechnologyLtd's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hangzhou Huawang New Material TechnologyLtd has CN¥1.78b in net cash and a decent-looking balance sheet. So we don't have any problem with Hangzhou Huawang New Material TechnologyLtd'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 1 warning sign with Hangzhou Huawang New Material TechnologyLtd , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.