David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Wenfeng Great World Chain Development Corporation (SHSE:601010) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Wenfeng Great World Chain Development

How Much Debt Does Wenfeng Great World Chain Development Carry?

You can click the graphic below for the historical numbers, but it shows that Wenfeng Great World Chain Development had CN¥90.1m of debt in March 2023, down from CN¥410.4m, one year before. However, it does have CN¥1.33b in cash offsetting this, leading to net cash of CN¥1.24b.

How Strong Is Wenfeng Great World Chain Development's Balance Sheet?

We can see from the most recent balance sheet that Wenfeng Great World Chain Development had liabilities of CN¥2.09b falling due within a year, and liabilities of CN¥188.3m due beyond that. On the other hand, it had cash of CN¥1.33b and CN¥72.4m worth of receivables due within a year. So its liabilities total CN¥871.6m more than the combination of its cash and short-term receivables.

Given Wenfeng Great World Chain Development has a market capitalization of CN¥5.05b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Wenfeng Great World Chain Development boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Wenfeng Great World Chain Development's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Wenfeng Great World Chain Development will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Wenfeng Great World Chain Development 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, Wenfeng Great World Chain Development actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Wenfeng Great World Chain Development'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¥1.24b. The cherry on top was that in converted 141% of that EBIT to free cash flow, bringing in CN¥487m. So we are not troubled with Wenfeng Great World Chain Development's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Wenfeng Great World Chain Development .

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.