Here's Why Shaanxi Coal Industry (SHSE:601225) Can Manage Its Debt Responsibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shaanxi Coal Industry Company Limited (SHSE:601225) does carry debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

View our latest analysis for Shaanxi Coal Industry

How Much Debt Does Shaanxi Coal Industry Carry?

You can click the graphic below for the historical numbers, but it shows that Shaanxi Coal Industry had CN¥3.47b of debt in September 2024, down from CN¥4.98b, one year before. However, its balance sheet shows it holds CN¥44.8b in cash, so it actually has CN¥41.4b net cash.

How Healthy Is Shaanxi Coal Industry's Balance Sheet?

According to the last reported balance sheet, Shaanxi Coal Industry had liabilities of CN¥43.5b due within 12 months, and liabilities of CN¥28.6b due beyond 12 months. Offsetting these obligations, it had cash of CN¥44.8b as well as receivables valued at CN¥4.84b due within 12 months. So its liabilities total CN¥22.4b more than the combination of its cash and short-term receivables.

Of course, Shaanxi Coal Industry has a titanic market capitalization of CN¥210.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Shaanxi Coal Industry also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Shaanxi Coal Industry's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Shaanxi Coal Industry'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. Shaanxi Coal Industry 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. Over the last three years, Shaanxi Coal Industry recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

Although Shaanxi Coal Industry's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥41.4b. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥31b. So we don't have any problem with Shaanxi Coal Industry's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Shaanxi Coal Industry .

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.