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.' 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. Importantly, Zhejiang Supor Co., Ltd. (SZSE:002032) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhejiang Supor Carry?

As you can see below, at the end of September 2023, Zhejiang Supor had CN¥190.9m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥3.21b in cash offsetting this, leading to net cash of CN¥3.02b.

How Healthy Is Zhejiang Supor's Balance Sheet?

According to the last reported balance sheet, Zhejiang Supor had liabilities of CN¥6.04b due within 12 months, and liabilities of CN¥154.3m due beyond 12 months. On the other hand, it had cash of CN¥3.21b and CN¥3.33b worth of receivables due within a year. So it can boast CN¥352.8m more liquid assets than total liabilities.

This state of affairs indicates that Zhejiang Supor'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¥46.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Zhejiang Supor has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Zhejiang Supor has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Supor's ability to maintain a healthy balance sheet going forward. 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. Zhejiang Supor 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, Zhejiang Supor recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Supor has net cash of CN¥3.02b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.2b, being 97% of its EBIT. So we don't think Zhejiang Supor's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Zhejiang Supor , and understanding them should be part of your investment process.

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.