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.' 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 ZKH Group Limited (NYSE:ZKH) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is ZKH Group's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 ZKH Group had debt of CN¥701.0m, up from CN¥560.2m in one year. However, its balance sheet shows it holds CN¥1.89b in cash, so it actually has CN¥1.18b net cash.

How Strong Is ZKH Group's Balance Sheet?

According to the last reported balance sheet, ZKH Group had liabilities of CN¥3.59b due within 12 months, and liabilities of CN¥130.2m due beyond 12 months. Offsetting this, it had CN¥1.89b in cash and CN¥3.63b in receivables that were due within 12 months. So it actually has CN¥1.80b more liquid assets than total liabilities.

This surplus liquidity suggests that ZKH Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, ZKH Group boasts net cash, so it's fair to say it does not have a heavy debt load! 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 ZKH Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year ZKH Group wasn't profitable at an EBIT level, but managed to grow its revenue by 3.0%, to CN¥8.6b. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is ZKH Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that ZKH Group had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥624m and booked a CN¥901m accounting loss. But the saving grace is the CN¥1.18b on the balance sheet. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. For example, we've discovered 1 warning sign for ZKH Group that you should be aware of before investing here.

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.

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