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 Zhejiang Taotao Vehicles Co., Ltd. (SZSE:301345) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Zhejiang Taotao Vehicles Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Zhejiang Taotao Vehicles had debt of CN¥551.4m, up from CN¥479.0m in one year. However, its balance sheet shows it holds CN¥1.71b in cash, so it actually has CN¥1.16b net cash.

How Healthy Is Zhejiang Taotao Vehicles' Balance Sheet?

According to the last reported balance sheet, Zhejiang Taotao Vehicles had liabilities of CN¥1.40b due within 12 months, and liabilities of CN¥88.5m due beyond 12 months. Offsetting this, it had CN¥1.71b in cash and CN¥614.7m in receivables that were due within 12 months. So it can boast CN¥835.0m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Taotao Vehicles has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Taotao Vehicles has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Zhejiang Taotao Vehicles has boosted its EBIT by 74%, thus reducing the spectre of future debt repayments. 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 Zhejiang Taotao Vehicles can strengthen its balance sheet over time. 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. Zhejiang Taotao Vehicles 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. Over the last three years, Zhejiang Taotao Vehicles recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Taotao Vehicles has net cash of CN¥1.16b, as well as more liquid assets than liabilities. And we liked the look of last year's 74% year-on-year EBIT growth. So we don't have any problem with Zhejiang Taotao Vehicles's use of debt. 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. For example Zhejiang Taotao Vehicles has 2 warning signs (and 1 which is potentially serious) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.