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.' 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. We can see that XTC New Energy Materials(Xiamen) Co.,Ltd. (SHSE:688778) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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, 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 XTC New Energy Materials(Xiamen)Ltd's Net Debt?

The image below, which you can click on for greater detail, shows that XTC New Energy Materials(Xiamen)Ltd had debt of CN¥1.62b at the end of March 2024, a reduction from CN¥1.75b over a year. But on the other hand it also has CN¥2.78b in cash, leading to a CN¥1.16b net cash position.

How Strong Is XTC New Energy Materials(Xiamen)Ltd's Balance Sheet?

We can see from the most recent balance sheet that XTC New Energy Materials(Xiamen)Ltd had liabilities of CN¥4.56b falling due within a year, and liabilities of CN¥924.5m due beyond that. Offsetting these obligations, it had cash of CN¥2.78b as well as receivables valued at CN¥3.52b due within 12 months. So it actually has CN¥819.0m more liquid assets than total liabilities.

This short term liquidity is a sign that XTC New Energy Materials(Xiamen)Ltd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, XTC New Energy Materials(Xiamen)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that XTC New Energy Materials(Xiamen)Ltd's load is not too heavy, because its EBIT was down 36% 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 XTC New Energy Materials(Xiamen)Ltd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. XTC New Energy Materials(Xiamen)Ltd 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. During the last three years, XTC New Energy Materials(Xiamen)Ltd 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

While we empathize with investors who find debt concerning, you should keep in mind that XTC New Energy Materials(Xiamen)Ltd has net cash of CN¥1.16b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about XTC New Energy Materials(Xiamen)Ltd's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for XTC New Energy Materials(Xiamen)Ltd that 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.