Warren Buffett famously said, '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 Zhongjin Gold Corp.,Ltd (SHSE:600489) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Zhongjin GoldLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhongjin GoldLtd had CN¥16.2b of debt, an increase on CN¥13.1b, over one year. However, because it has a cash reserve of CN¥9.57b, its net debt is less, at about CN¥6.63b.

How Strong Is Zhongjin GoldLtd's Balance Sheet?

According to the last reported balance sheet, Zhongjin GoldLtd had liabilities of CN¥16.9b due within 12 months, and liabilities of CN¥6.75b due beyond 12 months. Offsetting these obligations, it had cash of CN¥9.57b as well as receivables valued at CN¥926.0m due within 12 months. So it has liabilities totalling CN¥13.1b more than its cash and near-term receivables, combined.

Zhongjin GoldLtd has a market capitalization of CN¥64.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Zhongjin GoldLtd's net debt is only 0.98 times its EBITDA. And its EBIT easily covers its interest expense, being 41.6 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Zhongjin GoldLtd has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. 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 Zhongjin GoldLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Zhongjin GoldLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Zhongjin GoldLtd's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Considering this range of factors, it seems to us that Zhongjin GoldLtd is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. Case in point: We've spotted 1 warning sign for Zhongjin GoldLtd you should be aware of.

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.