The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Zhejiang Huangma Technology Co.,Ltd (SHSE:603181) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Zhejiang Huangma TechnologyLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Zhejiang Huangma TechnologyLtd had CN¥380.9m in debt in March 2024; about the same as the year before. However, it does have CN¥699.2m in cash offsetting this, leading to net cash of CN¥318.3m.

How Strong Is Zhejiang Huangma TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Zhejiang Huangma TechnologyLtd had liabilities of CN¥438.2m due within 12 months, and liabilities of CN¥266.7m due beyond 12 months. Offsetting this, it had CN¥699.2m in cash and CN¥376.0m in receivables that were due within 12 months. So it actually has CN¥370.3m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Huangma TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Huangma TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Zhejiang Huangma TechnologyLtd has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zhejiang Huangma TechnologyLtd's ability to maintain a healthy balance sheet going forward. 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. While Zhejiang Huangma TechnologyLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Zhejiang Huangma TechnologyLtd's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Huangma TechnologyLtd has CN¥318.3m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 24% over the last year. So is Zhejiang Huangma TechnologyLtd'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. Case in point: We've spotted 1 warning sign for Zhejiang Huangma TechnologyLtd you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.