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. As with many other companies Jiangsu Shagang Co., Ltd. (SZSE:002075) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Jiangsu Shagang's Debt?

As you can see below, at the end of September 2023, Jiangsu Shagang had CN¥4.24b of debt, up from CN¥1.12b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥8.46b in cash, so it actually has CN¥4.22b net cash.

A Look At Jiangsu Shagang's Liabilities

According to the last reported balance sheet, Jiangsu Shagang had liabilities of CN¥8.89b due within 12 months, and liabilities of CN¥703.7m due beyond 12 months. On the other hand, it had cash of CN¥8.46b and CN¥426.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥709.0m.

Given Jiangsu Shagang has a market capitalization of CN¥9.96b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Jiangsu Shagang also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Jiangsu Shagang's saving grace is its low debt levels, because its EBIT has tanked 95% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jiangsu Shagang will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jiangsu Shagang 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, Jiangsu Shagang actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Jiangsu Shagang's liabilities, but we can be reassured by the fact it has has net cash of CN¥4.22b. And it impressed us with free cash flow of CN¥749m, being 105% of its EBIT. So we are not troubled with Jiangsu Shagang's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Jiangsu Shagang (1 doesn't sit too well with us) you should be aware of.

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.