Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Changzhou Fusion New Material Co., Ltd. (SHSE:688503) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Changzhou Fusion New Material's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Changzhou Fusion New Material had CN¥1.94b of debt, an increase on CN¥765.6m, over one year. But on the other hand it also has CN¥2.14b in cash, leading to a CN¥207.2m net cash position.

How Strong Is Changzhou Fusion New Material's Balance Sheet?

We can see from the most recent balance sheet that Changzhou Fusion New Material had liabilities of CN¥2.55b falling due within a year, and liabilities of CN¥23.4m due beyond that. Offsetting this, it had CN¥2.14b in cash and CN¥3.26b in receivables that were due within 12 months. So it can boast CN¥2.82b more liquid assets than total liabilities.

It's good to see that Changzhou Fusion New Material has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Changzhou Fusion New Material has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Changzhou Fusion New Material grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its 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 Changzhou Fusion New Material'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Changzhou Fusion New Material 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, Changzhou Fusion New Material saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Changzhou Fusion New Material has net cash of CN¥207.2m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 42% over the last year. So is Changzhou Fusion New Material's debt a risk? It doesn't seem so to us. 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. We've identified 3 warning signs with Changzhou Fusion New Material (at least 1 which can't be ignored) , 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.