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.' 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 can see that Yunnan Baiyao Group Co.,Ltd (SZSE:000538) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Yunnan Baiyao GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that Yunnan Baiyao GroupLtd had debt of CN¥1.72b at the end of March 2024, a reduction from CN¥1.86b over a year. But it also has CN¥17.2b in cash to offset that, meaning it has CN¥15.4b net cash.

A Look At Yunnan Baiyao GroupLtd's Liabilities

According to the last reported balance sheet, Yunnan Baiyao GroupLtd had liabilities of CN¥14.1b due within 12 months, and liabilities of CN¥1.14b due beyond 12 months. Offsetting this, it had CN¥17.2b in cash and CN¥13.8b in receivables that were due within 12 months. So it can boast CN¥15.7b more liquid assets than total liabilities.

This surplus suggests that Yunnan Baiyao GroupLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Yunnan Baiyao GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Yunnan Baiyao GroupLtd grew its EBIT by 4.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yunnan Baiyao GroupLtd'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Yunnan Baiyao GroupLtd 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. During the last three years, Yunnan Baiyao GroupLtd generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yunnan Baiyao GroupLtd has CN¥15.4b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in CN¥2.8b. So we don't think Yunnan Baiyao GroupLtd'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. We've identified 1 warning sign with Yunnan Baiyao GroupLtd , and understanding them should be part of your investment process.

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.

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