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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Shandong Yulong Gold Co., Ltd. (SHSE:601028) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shandong Yulong Gold's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Shandong Yulong Gold had debt of CN¥1.75b, up from CN¥1.17b in one year. But it also has CN¥1.92b in cash to offset that, meaning it has CN¥175.4m net cash.

A Look At Shandong Yulong Gold's Liabilities

According to the last reported balance sheet, Shandong Yulong Gold had liabilities of CN¥4.37b due within 12 months, and liabilities of CN¥760.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.92b as well as receivables valued at CN¥1.92b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.29b.

Since publicly traded Shandong Yulong Gold shares are worth a total of CN¥9.50b, it seems unlikely that this level of liabilities would be a major 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, Shandong Yulong Gold also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Shandong Yulong Gold grew its EBIT by 41% over the last twelve months, and that growth will make it easier to handle its 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 Shandong Yulong Gold'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. Shandong Yulong Gold 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, Shandong Yulong Gold 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

Although Shandong Yulong Gold's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥175.4m. And it impressed us with its EBIT growth of 41% over the last year. So we are not troubled with Shandong Yulong Gold's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Shandong Yulong Gold you should be aware of, and 1 of them is significant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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