David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Yum China Holdings, Inc. (NYSE:YUMC) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Yum China Holdings's Net Debt?

As you can see below, at the end of June 2024, Yum China Holdings had US$416.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$2.48b in cash, leading to a US$2.06b net cash position.

A Look At Yum China Holdings' Liabilities

We can see from the most recent balance sheet that Yum China Holdings had liabilities of US$2.68b falling due within a year, and liabilities of US$2.41b due beyond that. Offsetting these obligations, it had cash of US$2.48b as well as receivables valued at US$74.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.54b.

Since publicly traded Yum China Holdings shares are worth a very impressive total of US$13.0b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Yum China Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Yum China Holdings grew its EBIT at 12% over the last year, further increasing its ability to manage debt. 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 Yum China Holdings'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. Yum China Holdings 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, Yum China Holdings produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Yum China Holdings does have more liabilities than liquid assets, it also has net cash of US$2.06b. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in US$656m. So we don't think Yum China Holdings's use of debt is risky. 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 Yum China Holdings you should be aware of.

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.