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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Zhongtong Bus Holding Co.,LTD (SZSE:000957) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Zhongtong Bus HoldingLTD's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhongtong Bus HoldingLTD had CN¥484.3m of debt in March 2024, down from CN¥1.05b, one year before. But it also has CN¥2.34b in cash to offset that, meaning it has CN¥1.86b net cash.

A Look At Zhongtong Bus HoldingLTD's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhongtong Bus HoldingLTD had liabilities of CN¥5.66b due within 12 months and liabilities of CN¥454.2m due beyond that. On the other hand, it had cash of CN¥2.34b and CN¥3.44b worth of receivables due within a year. So it has liabilities totalling CN¥333.3m more than its cash and near-term receivables, combined.

Given Zhongtong Bus HoldingLTD has a market capitalization of CN¥6.37b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Zhongtong Bus HoldingLTD boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Zhongtong Bus HoldingLTD's EBIT was down 43% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zhongtong Bus HoldingLTD will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Zhongtong Bus HoldingLTD 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, Zhongtong Bus HoldingLTD actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Zhongtong Bus HoldingLTD has CN¥1.86b in net cash. The cherry on top was that in converted 1,555% of that EBIT to free cash flow, bringing in CN¥1.1b. So we don't have any problem with Zhongtong Bus HoldingLTD's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Zhongtong Bus HoldingLTD has 3 warning signs we think 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com