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. Importantly, Lao Feng Xiang Co., Ltd. (SHSE:600612) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Lao Feng Xiang's Debt?

The chart below, which you can click on for greater detail, shows that Lao Feng Xiang had CN¥8.32b in debt in September 2023; about the same as the year before. However, it does have CN¥11.1b in cash offsetting this, leading to net cash of CN¥2.79b.

How Healthy Is Lao Feng Xiang's Balance Sheet?

We can see from the most recent balance sheet that Lao Feng Xiang had liabilities of CN¥12.6b falling due within a year, and liabilities of CN¥311.8m due beyond that. Offsetting these obligations, it had cash of CN¥11.1b as well as receivables valued at CN¥6.64b due within 12 months. So it actually has CN¥4.85b more liquid assets than total liabilities.

This surplus suggests that Lao Feng Xiang is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Lao Feng Xiang boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Lao Feng Xiang has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lao Feng Xiang 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. Lao Feng Xiang 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. Happily for any shareholders, Lao Feng Xiang actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Lao Feng Xiang has CN¥2.79b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in CN¥4.8b. So we don't think Lao Feng Xiang's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Lao Feng Xiang, you may well want to click here to check an interactive graph of its earnings per share history.

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.