Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Do-Fluoride New Materials Co., Ltd. (SZSE:002407) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Do-Fluoride New Materials

What Is Do-Fluoride New Materials's Net Debt?

The image below, which you can click on for greater detail, shows that Do-Fluoride New Materials had debt of CN¥1.88b at the end of March 2022, a reduction from CN¥3.53b over a year. However, it does have CN¥1.90b in cash offsetting this, leading to net cash of CN¥16.5m.

A Look At Do-Fluoride New Materials' Liabilities

According to the last reported balance sheet, Do-Fluoride New Materials had liabilities of CN¥5.86b due within 12 months, and liabilities of CN¥1.13b due beyond 12 months. On the other hand, it had cash of CN¥1.90b and CN¥1.85b worth of receivables due within a year. So it has liabilities totalling CN¥3.24b more than its cash and near-term receivables, combined.

Of course, Do-Fluoride New Materials has a market capitalization of CN¥29.6b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Do-Fluoride New Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Do-Fluoride New Materials grew its EBIT by 1,568% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Do-Fluoride New Materials'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Do-Fluoride New Materials 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 two years, Do-Fluoride New Materials reported free cash flow worth 6.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

Although Do-Fluoride New Materials's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥16.5m. And we liked the look of last year's 1,568% year-on-year EBIT growth. So we don't have any problem with Do-Fluoride New Materials'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. Be aware that Do-Fluoride New Materials is showing 5 warning signs in our investment analysis , and 2 of those make us uncomfortable...

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.