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.' 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 can see that Zhejiang Xinan Chemical Industrial Group Co.,Ltd (SHSE:600596) does use debt in its business. But the real question is whether this debt is making the company risky.

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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Zhejiang Xinan Chemical Industrial GroupLtd

What Is Zhejiang Xinan Chemical Industrial GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Zhejiang Xinan Chemical Industrial GroupLtd had CN¥2.54b of debt, an increase on CN¥2.41b, over one year. However, its balance sheet shows it holds CN¥4.19b in cash, so it actually has CN¥1.65b net cash.

How Healthy Is Zhejiang Xinan Chemical Industrial GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhejiang Xinan Chemical Industrial GroupLtd had liabilities of CN¥5.71b due within 12 months and liabilities of CN¥1.70b due beyond that. Offsetting these obligations, it had cash of CN¥4.19b as well as receivables valued at CN¥3.40b due within 12 months. So it can boast CN¥174.2m more liquid assets than total liabilities.

This state of affairs indicates that Zhejiang Xinan Chemical Industrial GroupLtd'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¥18.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Zhejiang Xinan Chemical Industrial GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Zhejiang Xinan Chemical Industrial GroupLtd grew its EBIT by 105% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Xinan Chemical Industrial GroupLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang Xinan Chemical Industrial GroupLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Zhejiang Xinan Chemical Industrial GroupLtd recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Xinan Chemical Industrial GroupLtd has CN¥1.65b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 105% over the last year. So is Zhejiang Xinan Chemical Industrial GroupLtd's debt a risk? It doesn't seem so 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zhejiang Xinan Chemical Industrial GroupLtd you should know about.

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.