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 Ningbo Yongxin Optics Co.,Ltd (SHSE:603297) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Ningbo Yongxin OpticsLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Ningbo Yongxin OpticsLtd had CN¥40.1m in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥940.5m in cash, so it actually has CN¥900.4m net cash.

How Healthy Is Ningbo Yongxin OpticsLtd's Balance Sheet?

The latest balance sheet data shows that Ningbo Yongxin OpticsLtd had liabilities of CN¥207.9m due within a year, and liabilities of CN¥25.4m falling due after that. On the other hand, it had cash of CN¥940.5m and CN¥189.4m worth of receivables due within a year. So it actually has CN¥896.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Ningbo Yongxin OpticsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ningbo Yongxin OpticsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Ningbo Yongxin OpticsLtd's load is not too heavy, because its EBIT was down 26% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ningbo Yongxin OpticsLtd'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ningbo Yongxin OpticsLtd 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, Ningbo Yongxin OpticsLtd recorded free cash flow worth 58% 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 we empathize with investors who find debt concerning, you should keep in mind that Ningbo Yongxin OpticsLtd has net cash of CN¥900.4m, as well as more liquid assets than liabilities. So we don't have any problem with Ningbo Yongxin OpticsLtd's use of debt. 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 example, we've discovered 2 warning signs for Ningbo Yongxin OpticsLtd that you should be aware of before investing here.

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.