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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Xiamen Kingdomway Group Company (SZSE:002626) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Xiamen Kingdomway Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Xiamen Kingdomway Group had CN¥890.3m of debt in June 2024, down from CN¥1.04b, one year before. However, its balance sheet shows it holds CN¥917.7m in cash, so it actually has CN¥27.4m net cash.

A Look At Xiamen Kingdomway Group's Liabilities

We can see from the most recent balance sheet that Xiamen Kingdomway Group had liabilities of CN¥947.1m falling due within a year, and liabilities of CN¥688.6m due beyond that. Offsetting this, it had CN¥917.7m in cash and CN¥416.1m in receivables that were due within 12 months. So it has liabilities totalling CN¥301.9m more than its cash and near-term receivables, combined.

Since publicly traded Xiamen Kingdomway Group shares are worth a total of CN¥9.66b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Xiamen Kingdomway Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Xiamen Kingdomway Group grew its EBIT by 8.9% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Xiamen Kingdomway Group 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, a company can only pay off debt with cold hard cash, not accounting profits. While Xiamen Kingdomway 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. Over the last three years, Xiamen Kingdomway Group recorded free cash flow worth a fulsome 88% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Xiamen Kingdomway Group's liabilities, but we can be reassured by the fact it has has net cash of CN¥27.4m. The cherry on top was that in converted 88% of that EBIT to free cash flow, bringing in CN¥93m. So is Xiamen Kingdomway Group's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Xiamen Kingdomway Group has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.