Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Shede Spirits Co., Ltd. (SHSE:600702) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shede Spirits Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shede Spirits had CN¥795.1m of debt, an increase on CN¥137.1m, over one year. But it also has CN¥2.06b in cash to offset that, meaning it has CN¥1.26b net cash.

How Healthy Is Shede Spirits' Balance Sheet?

We can see from the most recent balance sheet that Shede Spirits had liabilities of CN¥3.91b falling due within a year, and liabilities of CN¥310.5m due beyond that. Offsetting these obligations, it had cash of CN¥2.06b as well as receivables valued at CN¥562.8m due within 12 months. So it has liabilities totalling CN¥1.60b more than its cash and near-term receivables, combined.

Of course, Shede Spirits has a market capitalization of CN¥24.2b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Shede Spirits boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Shede Spirits's load is not too heavy, because its EBIT was down 34% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shede Spirits's ability to maintain a healthy balance sheet going forward. 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. Shede Spirits 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 three years, Shede Spirits actually recorded a cash outflow, overall. 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Shede Spirits has CN¥1.26b in net cash. So although we see some areas for improvement, we're not too worried about Shede Spirits's balance sheet. 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. Be aware that Shede Spirits is showing 3 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.