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. Importantly, Do-Fluoride New Materials Co., Ltd. (SZSE:002407) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Do-Fluoride New Materials's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Do-Fluoride New Materials had CN¥5.53b of debt, an increase on CN¥3.63b, over one year. But it also has CN¥6.96b in cash to offset that, meaning it has CN¥1.43b net cash.

How Strong Is Do-Fluoride New Materials' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Do-Fluoride New Materials had liabilities of CN¥7.19b due within 12 months and liabilities of CN¥5.07b due beyond that. Offsetting these obligations, it had cash of CN¥6.96b as well as receivables valued at CN¥3.46b due within 12 months. So its liabilities total CN¥1.84b more than the combination of its cash and short-term receivables.

Since publicly traded Do-Fluoride New Materials shares are worth a total of CN¥15.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Do-Fluoride New Materials boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Do-Fluoride New Materials's load is not too heavy, because its EBIT was down 69% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Do-Fluoride New Materials'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 company can only pay off debt with cold hard cash, not accounting profits. While Do-Fluoride New Materials has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Do-Fluoride New Materials burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

Although Do-Fluoride New Materials'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¥1.43b. So although we see some areas for improvement, we're not too worried about Do-Fluoride New Materials's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Do-Fluoride New Materials is showing 3 warning signs in our investment analysis , you should know about...

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.