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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Ganzhou Tengyuan Cobalt New Material Co., Ltd. (SZSE:301219) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Ganzhou Tengyuan Cobalt New Material's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Ganzhou Tengyuan Cobalt New Material had debt of CN¥302.4m, up from CN¥77.8m in one year. But on the other hand it also has CN¥3.76b in cash, leading to a CN¥3.46b net cash position.

A Look At Ganzhou Tengyuan Cobalt New Material's Liabilities

Zooming in on the latest balance sheet data, we can see that Ganzhou Tengyuan Cobalt New Material had liabilities of CN¥1.31b due within 12 months and liabilities of CN¥220.1m due beyond that. Offsetting this, it had CN¥3.76b in cash and CN¥541.1m in receivables that were due within 12 months. So it can boast CN¥2.77b more liquid assets than total liabilities.

This excess liquidity suggests that Ganzhou Tengyuan Cobalt New Material is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Ganzhou Tengyuan Cobalt New Material boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Ganzhou Tengyuan Cobalt New Material made a loss at the EBIT level, last year, it was also good to see that it generated CN¥495m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ganzhou Tengyuan Cobalt New Material's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Ganzhou Tengyuan Cobalt New Material 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. In the last year, Ganzhou Tengyuan Cobalt New Material's free cash flow amounted to 39% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Ganzhou Tengyuan Cobalt New Material has net cash of CN¥3.46b, as well as more liquid assets than liabilities. So is Ganzhou Tengyuan Cobalt New Material's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 3 warning signs we've spotted with Ganzhou Tengyuan Cobalt New Material .

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