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 can see that Emei Shan Tourism Co.,Ltd (SZSE:000888) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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 Emei Shan TourismLtd's Debt?

The chart below, which you can click on for greater detail, shows that Emei Shan TourismLtd had CN¥496.6m in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds CN¥1.38b in cash, so it actually has CN¥884.8m net cash.

How Strong Is Emei Shan TourismLtd's Balance Sheet?

We can see from the most recent balance sheet that Emei Shan TourismLtd had liabilities of CN¥273.8m falling due within a year, and liabilities of CN¥550.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.38b as well as receivables valued at CN¥74.9m due within 12 months. So it can boast CN¥632.2m more liquid assets than total liabilities.

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

Better yet, Emei Shan TourismLtd grew its EBIT by 741% 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 ultimately the future profitability of the business will decide if Emei Shan TourismLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Emei Shan TourismLtd 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 two years, Emei Shan TourismLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Emei Shan TourismLtd has CN¥884.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 134% of that EBIT to free cash flow, bringing in CN¥289m. So we don't think Emei Shan TourismLtd'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 Emei Shan TourismLtd is showing 2 warning signs 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.