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, Qinghai Huzhu TianYouDe Highland Barley Spirit Co., Ltd. (SZSE:002646) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Qinghai Huzhu TianYouDe Highland Barley Spirit Carry?

As you can see below, Qinghai Huzhu TianYouDe Highland Barley Spirit had CN¥109.5m of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥524.2m in cash, so it actually has CN¥414.7m net cash.

How Strong Is Qinghai Huzhu TianYouDe Highland Barley Spirit's Balance Sheet?

We can see from the most recent balance sheet that Qinghai Huzhu TianYouDe Highland Barley Spirit had liabilities of CN¥482.1m falling due within a year, and liabilities of CN¥42.8m due beyond that. Offsetting these obligations, it had cash of CN¥524.2m as well as receivables valued at CN¥32.4m due within 12 months. So it can boast CN¥31.7m more liquid assets than total liabilities.

This state of affairs indicates that Qinghai Huzhu TianYouDe Highland Barley Spirit's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥5.76b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Qinghai Huzhu TianYouDe Highland Barley Spirit boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Qinghai Huzhu TianYouDe Highland Barley Spirit grew its EBIT by 115% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Qinghai Huzhu TianYouDe Highland Barley Spirit 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Qinghai Huzhu TianYouDe Highland Barley Spirit 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, Qinghai Huzhu TianYouDe Highland Barley Spirit burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Qinghai Huzhu TianYouDe Highland Barley Spirit has net cash of CN¥414.7m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 115% over the last year. So we don't have any problem with Qinghai Huzhu TianYouDe Highland Barley Spirit's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Qinghai Huzhu TianYouDe Highland Barley Spirit has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.