Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Zhejiang Jinke Tom Culture Industry Co., LTD. (SZSE:300459) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhejiang Jinke Tom Culture Industry

How Much Debt Does Zhejiang Jinke Tom Culture Industry Carry?

As you can see below, Zhejiang Jinke Tom Culture Industry had CN¥1.80b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has CN¥465.3m in cash leading to net debt of about CN¥1.33b.

A Look At Zhejiang Jinke Tom Culture Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhejiang Jinke Tom Culture Industry had liabilities of CN¥1.44b due within 12 months and liabilities of CN¥560.2m due beyond that. Offsetting these obligations, it had cash of CN¥465.3m as well as receivables valued at CN¥401.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.13b.

Of course, Zhejiang Jinke Tom Culture Industry has a market capitalization of CN¥14.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Zhejiang Jinke Tom Culture Industry's debt is 3.3 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Importantly, Zhejiang Jinke Tom Culture Industry's EBIT fell a jaw-dropping 35% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Zhejiang Jinke Tom Culture Industry'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Zhejiang Jinke Tom Culture Industry actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen Zhejiang Jinke Tom Culture Industry is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. Looking at all this data makes us feel a little cautious about Zhejiang Jinke Tom Culture Industry's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Zhejiang Jinke Tom Culture Industry , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.