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.' 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 note that Qianhe Condiment and Food Co., Ltd. (SHSE:603027) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Qianhe Condiment and Food's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Qianhe Condiment and Food had debt of CN¥151.8m, up from none in one year. But on the other hand it also has CN¥1.41b in cash, leading to a CN¥1.25b net cash position.

How Strong Is Qianhe Condiment and Food's Balance Sheet?

The latest balance sheet data shows that Qianhe Condiment and Food had liabilities of CN¥686.2m due within a year, and liabilities of CN¥46.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.41b as well as receivables valued at CN¥147.7m due within 12 months. So it can boast CN¥822.2m more liquid assets than total liabilities.

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

But the bad news is that Qianhe Condiment and Food has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Qianhe Condiment and Food'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, a company can only pay off debt with cold hard cash, not accounting profits. Qianhe Condiment and Food 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. In the last three years, Qianhe Condiment and Food's free cash flow amounted to 42% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Qianhe Condiment and Food has net cash of CN¥1.25b, as well as more liquid assets than liabilities. So we are not troubled with Qianhe Condiment and Food's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Qianhe Condiment and Food, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.