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. We note that Zhewen Interactive Group Co., Ltd. (SHSE:600986) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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 Zhewen Interactive Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Zhewen Interactive Group had CN¥1.14b of debt, an increase on CN¥887.7m, over one year. However, its balance sheet shows it holds CN¥1.24b in cash, so it actually has CN¥97.5m net cash.

A Look At Zhewen Interactive Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhewen Interactive Group had liabilities of CN¥2.98b due within 12 months and liabilities of CN¥57.0m due beyond that. On the other hand, it had cash of CN¥1.24b and CN¥4.36b worth of receivables due within a year. So it can boast CN¥2.56b more liquid assets than total liabilities.

This excess liquidity is a great indication that Zhewen Interactive Group's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Zhewen Interactive Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Zhewen Interactive Group saw its EBIT drop by 6.2% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Zhewen Interactive Group can strengthen its balance sheet over time. 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. Zhewen Interactive 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 three years, Zhewen Interactive Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhewen Interactive Group has net cash of CN¥97.5m, as well as more liquid assets than liabilities. So we don't have any problem with Zhewen Interactive 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhewen Interactive Group you should know about.

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