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. As with many other companies Xtep International Holdings Limited (HKG:1368) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Xtep International Holdings

What Is Xtep International Holdings's Debt?

As you can see below, at the end of June 2022, Xtep International Holdings had CN¥2.98b of debt, up from CN¥1.95b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.81b in cash, so it actually has CN¥828.5m net cash.

How Strong Is Xtep International Holdings' Balance Sheet?

According to the last reported balance sheet, Xtep International Holdings had liabilities of CN¥4.92b due within 12 months, and liabilities of CN¥2.55b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.81b as well as receivables valued at CN¥3.67b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Xtep International Holdings' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥23.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Xtep International Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Xtep International Holdings has boosted its EBIT by 55%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Xtep International Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Xtep International Holdings 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 three years, Xtep International Holdings reported free cash flow worth 7.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Xtep International Holdings has CN¥828.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 55% year-on-year EBIT growth. So is Xtep International Holdings's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Xtep International Holdings that you should be aware of.

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.

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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.