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 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 note that Hoyuan Green Energy Co., Ltd. (SHSE:603185) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Hoyuan Green Energy

How Much Debt Does Hoyuan Green Energy Carry?

You can click the graphic below for the historical numbers, but it shows that Hoyuan Green Energy had CN¥602.6m of debt in September 2023, down from CN¥1.79b, one year before. However, its balance sheet shows it holds CN¥5.02b in cash, so it actually has CN¥4.41b net cash.

How Healthy Is Hoyuan Green Energy's Balance Sheet?

We can see from the most recent balance sheet that Hoyuan Green Energy had liabilities of CN¥11.6b falling due within a year, and liabilities of CN¥655.8m due beyond that. Offsetting these obligations, it had cash of CN¥5.02b as well as receivables valued at CN¥647.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.63b.

While this might seem like a lot, it is not so bad since Hoyuan Green Energy has a market capitalization of CN¥21.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Hoyuan Green Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Hoyuan Green Energy's load is not too heavy, because its EBIT was down 57% over the last year. 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 ultimately the future profitability of the business will decide if Hoyuan Green Energy 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hoyuan Green Energy 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, Hoyuan Green Energy reported free cash flow worth 3.8% 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 Hoyuan Green Energy does have more liabilities than liquid assets, it also has net cash of CN¥4.41b. So although we see some areas for improvement, we're not too worried about Hoyuan Green Energy's balance sheet. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Hoyuan Green Energy (of which 1 doesn't sit too well with us!) you should know about.

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.