Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 note that Hangzhou Turbine Power Group Co., Ltd. (SZSE:200771) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Hangzhou Turbine Power Group's Net Debt?

As you can see below, at the end of March 2024, Hangzhou Turbine Power Group had CN¥803.2m of debt, up from CN¥519.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.94b in cash, so it actually has CN¥2.13b net cash.

How Healthy Is Hangzhou Turbine Power Group's Balance Sheet?

We can see from the most recent balance sheet that Hangzhou Turbine Power Group had liabilities of CN¥6.01b falling due within a year, and liabilities of CN¥1.58b due beyond that. On the other hand, it had cash of CN¥2.94b and CN¥3.78b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥871.7m.

Given Hangzhou Turbine Power Group has a market capitalization of CN¥7.98b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Hangzhou Turbine Power Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Hangzhou Turbine Power Group grew its EBIT by 83% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hangzhou Turbine Power Group will need earnings to service that debt. 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 Hangzhou Turbine Power Group 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. Considering the last three years, Hangzhou Turbine Power Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While Hangzhou Turbine Power Group does have more liabilities than liquid assets, it also has net cash of CN¥2.13b. And we liked the look of last year's 83% year-on-year EBIT growth. So we don't have any problem with Hangzhou Turbine Power Group'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 Hangzhou Turbine Power Group has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.

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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.