Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Sanquan Food Co., Ltd. (SZSE:002216) does carry 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Sanquan Food's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Sanquan Food had CN¥260.4m of debt, an increase on CN¥150.0m, over one year. However, it does have CN¥1.76b in cash offsetting this, leading to net cash of CN¥1.50b.

A Look At Sanquan Food's Liabilities

Zooming in on the latest balance sheet data, we can see that Sanquan Food had liabilities of CN¥2.27b due within 12 months and liabilities of CN¥262.9m due beyond that. Offsetting these obligations, it had cash of CN¥1.76b as well as receivables valued at CN¥446.3m due within 12 months. So it has liabilities totalling CN¥327.5m more than its cash and near-term receivables, combined.

Given Sanquan Food has a market capitalization of CN¥10.6b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Sanquan Food boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Sanquan Food saw its EBIT decline by 3.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sanquan Food 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. Sanquan 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. During the last three years, Sanquan Food produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Sanquan Food's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.50b. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥591m. So is Sanquan Food'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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Sanquan Food you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.