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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Qingdao Hanhe Cable Co.,Ltd (SZSE:002498) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Qingdao Hanhe CableLtd

What Is Qingdao Hanhe CableLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Qingdao Hanhe CableLtd had CN¥1.11b of debt in September 2023, down from CN¥1.15b, one year before. However, its balance sheet shows it holds CN¥1.43b in cash, so it actually has CN¥328.3m net cash.

How Strong Is Qingdao Hanhe CableLtd's Balance Sheet?

We can see from the most recent balance sheet that Qingdao Hanhe CableLtd had liabilities of CN¥2.61b falling due within a year, and liabilities of CN¥143.3m due beyond that. On the other hand, it had cash of CN¥1.43b and CN¥4.55b worth of receivables due within a year. So it actually has CN¥3.23b more liquid assets than total liabilities.

This excess liquidity suggests that Qingdao Hanhe CableLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Qingdao Hanhe CableLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Qingdao Hanhe CableLtd has increased its EBIT by 5.1% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qingdao Hanhe CableLtd can strengthen its balance sheet over time. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Qingdao Hanhe CableLtd 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. Looking at the most recent three years, Qingdao Hanhe CableLtd recorded free cash flow of 21% of its EBIT, which is weaker 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 Qingdao Hanhe CableLtd has net cash of CN¥328.3m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 5.1% in the last twelve months. So is Qingdao Hanhe CableLtd's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Qingdao Hanhe CableLtd 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.