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.' 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 Shanghai Haixin Group Co., Ltd. (SHSE:600851) does have debt on its balance sheet. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shanghai Haixin Group Carry?

As you can see below, at the end of March 2024, Shanghai Haixin Group had CN¥37.0m of debt, up from CN¥27.7m a year ago. Click the image for more detail. However, it does have CN¥762.8m in cash offsetting this, leading to net cash of CN¥725.8m.

A Look At Shanghai Haixin Group's Liabilities

We can see from the most recent balance sheet that Shanghai Haixin Group had liabilities of CN¥337.5m falling due within a year, and liabilities of CN¥429.3m due beyond that. Offsetting this, it had CN¥762.8m in cash and CN¥158.5m in receivables that were due within 12 months. So it can boast CN¥154.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Haixin Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Haixin Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Shanghai Haixin Group grew its EBIT by 340% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Haixin Group 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. Shanghai Haixin Group 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 two years, Shanghai Haixin Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Haixin Group has CN¥725.8m in net cash and a decent-looking balance sheet. And we liked the look of last year's 340% year-on-year EBIT growth. So we don't have any problem with Shanghai Haixin Group's use of debt. 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. We've identified 1 warning sign with Shanghai Haixin Group , and understanding them should be part of your investment process.

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.

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