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. As with many other companies Ningbo Xusheng Group Co., Ltd. (SHSE:603305) makes use of debt. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Ningbo Xusheng Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Ningbo Xusheng Group had CN¥2.33b of debt, an increase on CN¥1.76b, over one year. However, it does have CN¥2.65b in cash offsetting this, leading to net cash of CN¥322.5m.

How Strong Is Ningbo Xusheng Group's Balance Sheet?

We can see from the most recent balance sheet that Ningbo Xusheng Group had liabilities of CN¥2.94b falling due within a year, and liabilities of CN¥1.39b due beyond that. On the other hand, it had cash of CN¥2.65b and CN¥1.32b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥353.3m.

Given Ningbo Xusheng Group has a market capitalization of CN¥10.1b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Ningbo Xusheng Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that Ningbo Xusheng Group has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ningbo Xusheng Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ningbo Xusheng Group 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. Over the last three years, Ningbo Xusheng Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ningbo Xusheng Group has CN¥322.5m in net cash. So although we see some areas for improvement, we're not too worried about Ningbo Xusheng Group's balance sheet. 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 instance, we've identified 1 warning sign for Ningbo Xusheng Group that 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