The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shanghai Ziyan Foods Co., Ltd. (SHSE:603057) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shanghai Ziyan Foods's Net Debt?

As you can see below, at the end of March 2024, Shanghai Ziyan Foods had CN¥199.3m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥1.23b in cash, leading to a CN¥1.03b net cash position.

A Look At Shanghai Ziyan Foods' Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Ziyan Foods had liabilities of CN¥771.8m due within 12 months and liabilities of CN¥187.9m due beyond that. On the other hand, it had cash of CN¥1.23b and CN¥186.3m worth of receivables due within a year. So it can boast CN¥457.2m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Shanghai Ziyan Foods has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Ziyan Foods'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanghai Ziyan Foods 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. During the last three years, Shanghai Ziyan Foods produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. 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 Shanghai Ziyan Foods has CN¥1.03b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 48% over the last year. So is Shanghai Ziyan Foods'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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Shanghai Ziyan Foods (1 is a bit concerning!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.