Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Hengbao Co.,Ltd. (SZSE:002104) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is HengbaoLtd's Debt?

The image below, which you can click on for greater detail, shows that HengbaoLtd had debt of CN¥45.4m at the end of September 2023, a reduction from CN¥66.9m over a year. But on the other hand it also has CN¥976.3m in cash, leading to a CN¥930.9m net cash position.

A Look At HengbaoLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that HengbaoLtd had liabilities of CN¥217.1m due within 12 months and liabilities of CN¥7.29m due beyond that. On the other hand, it had cash of CN¥976.3m and CN¥320.8m worth of receivables due within a year. So it can boast CN¥1.07b more liquid assets than total liabilities.

It's good to see that HengbaoLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, HengbaoLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, HengbaoLtd grew its EBIT by 160% last year, which is an impressive improvement. 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 it is HengbaoLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While HengbaoLtd 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 last three years, HengbaoLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case HengbaoLtd has CN¥930.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 160% over the last year. So we don't think HengbaoLtd's use of debt is risky. 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. Be aware that HengbaoLtd is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.