Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Jiangsu Huahong Technology Co., Ltd. (SZSE:002645) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Jiangsu Huahong Technology

What Is Jiangsu Huahong Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Jiangsu Huahong Technology had debt of CN¥543.9m, up from CN¥150.2m in one year. But on the other hand it also has CN¥702.0m in cash, leading to a CN¥158.1m net cash position.

How Healthy Is Jiangsu Huahong Technology's Balance Sheet?

The latest balance sheet data shows that Jiangsu Huahong Technology had liabilities of CN¥1.57b due within a year, and liabilities of CN¥237.1m falling due after that. Offsetting these obligations, it had cash of CN¥702.0m as well as receivables valued at CN¥685.1m due within 12 months. So it has liabilities totalling CN¥422.0m more than its cash and near-term receivables, combined.

Given Jiangsu Huahong Technology has a market capitalization of CN¥12.4b, it's hard to believe these liabilities pose much threat. 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, Jiangsu Huahong Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Jiangsu Huahong Technology grew its EBIT by 51% over the last twelve months, and that growth will make it easier to handle its debt. 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 Jiangsu Huahong Technology'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. Jiangsu Huahong Technology 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, Jiangsu Huahong Technology reported free cash flow worth 9.0% 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

We could understand if investors are concerned about Jiangsu Huahong Technology's liabilities, but we can be reassured by the fact it has has net cash of CN¥158.1m. And we liked the look of last year's 51% year-on-year EBIT growth. So is Jiangsu Huahong Technology'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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Jiangsu Huahong Technology is showing 2 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.