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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Shiyue Daotian Group Co., Ltd. (HKG:9676) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Shiyue Daotian Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Shiyue Daotian Group had CN¥500.4m of debt in June 2024, down from CN¥3.10b, one year before. But it also has CN¥944.7m in cash to offset that, meaning it has CN¥444.3m net cash.

A Look At Shiyue Daotian Group's Liabilities

According to the last reported balance sheet, Shiyue Daotian Group had liabilities of CN¥786.9m due within 12 months, and liabilities of CN¥81.4m due beyond 12 months. On the other hand, it had cash of CN¥944.7m and CN¥390.6m worth of receivables due within a year. So it can boast CN¥467.0m more liquid assets than total liabilities.

This surplus suggests that Shiyue Daotian Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shiyue Daotian Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Shiyue Daotian Group made a loss at the EBIT level, last year, it was also good to see that it generated CN¥200m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shiyue Daotian Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shiyue Daotian Group 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. Considering the last year, Shiyue Daotian Group actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shiyue Daotian Group has net cash of CN¥444.3m, as well as more liquid assets than liabilities. So we are not troubled with Shiyue Daotian Group's debt use. 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 2 warning signs for Shiyue Daotian Group that you should be aware of before investing here.

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.