Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Ningbo Xusheng Group Co., Ltd. (SHSE:603305) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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.

What Is Ningbo Xusheng Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Ningbo Xusheng Group had CN¥2.05b of debt in September 2023, down from CN¥2.22b, one year before. However, it does have CN¥2.42b in cash offsetting this, leading to net cash of CN¥374.4m.

How Strong Is Ningbo Xusheng Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Ningbo Xusheng Group had liabilities of CN¥2.12b due within 12 months and liabilities of CN¥1.74b due beyond that. Offsetting these obligations, it had cash of CN¥2.42b as well as receivables valued at CN¥1.40b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Ningbo Xusheng Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥13.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Ningbo Xusheng Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Ningbo Xusheng Group has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. 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 Ningbo Xusheng Group can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Ningbo Xusheng Group 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. Over the last three years, Ningbo Xusheng Group saw substantial negative free cash flow, in total. 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

We could understand if investors are concerned about Ningbo Xusheng Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥374.4m. And we liked the look of last year's 33% year-on-year EBIT growth. So we are not troubled with Ningbo Xusheng Group'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. For example, we've discovered 1 warning sign for Ningbo Xusheng Group that you should be aware of before investing here.

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.