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. As with many other companies Hangzhou Turbine Power Group Co., Ltd. (SZSE:200771) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hangzhou Turbine Power Group

What Is Hangzhou Turbine Power Group's Debt?

As you can see below, at the end of September 2023, Hangzhou Turbine Power Group had CN¥667.8m of debt, up from CN¥489.7m a year ago. Click the image for more detail. However, it does have CN¥3.24b in cash offsetting this, leading to net cash of CN¥2.57b.

A Look At Hangzhou Turbine Power Group's Liabilities

The latest balance sheet data shows that Hangzhou Turbine Power Group had liabilities of CN¥6.41b due within a year, and liabilities of CN¥1.72b falling due after that. Offsetting these obligations, it had cash of CN¥3.24b as well as receivables valued at CN¥3.77b due within 12 months. So its liabilities total CN¥1.12b more than the combination of its cash and short-term receivables.

Given Hangzhou Turbine Power Group has a market capitalization of CN¥7.82b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Hangzhou Turbine Power Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Hangzhou Turbine Power Group's load is not too heavy, because its EBIT was down 47% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hangzhou Turbine Power Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hangzhou Turbine Power 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. Over the most recent three years, Hangzhou Turbine Power Group recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Hangzhou Turbine Power Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.57b. So we don't have any problem with Hangzhou Turbine Power Group'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. We've identified 2 warning signs with Hangzhou Turbine Power Group , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.