Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Shanghai Milkground Food Tech Co., Ltd (SHSE:600882) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shanghai Milkground Food Tech's Debt?

As you can see below, at the end of March 2024, Shanghai Milkground Food Tech had CN¥1.40b of debt, up from CN¥1.26b a year ago. Click the image for more detail. But on the other hand it also has CN¥2.56b in cash, leading to a CN¥1.16b net cash position.

How Strong Is Shanghai Milkground Food Tech's Balance Sheet?

According to the last reported balance sheet, Shanghai Milkground Food Tech had liabilities of CN¥1.66b due within 12 months, and liabilities of CN¥782.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.56b as well as receivables valued at CN¥130.5m due within 12 months. So it can boast CN¥243.8m more liquid assets than total liabilities.

This surplus suggests that Shanghai Milkground Food Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Milkground Food Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shanghai Milkground Food Tech's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Milkground Food Tech 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Shanghai Milkground Food Tech 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, Shanghai Milkground Food Tech 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 we empathize with investors who find debt concerning, you should keep in mind that Shanghai Milkground Food Tech has net cash of CN¥1.16b, as well as more liquid assets than liabilities. So while Shanghai Milkground Food Tech does not have a great balance sheet, it's certainly not too bad. 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. For instance, we've identified 1 warning sign for Shanghai Milkground Food Tech 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