David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Anhui Hengyuan Coal Industry and Electricity Power Co.,Ltd (SHSE:600971) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Anhui Hengyuan Coal Industry and Electricity PowerLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Anhui Hengyuan Coal Industry and Electricity PowerLtd had debt of CN¥1.96b, up from CN¥1.69b in one year. However, it does have CN¥7.46b in cash offsetting this, leading to net cash of CN¥5.50b.

How Strong Is Anhui Hengyuan Coal Industry and Electricity PowerLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anhui Hengyuan Coal Industry and Electricity PowerLtd had liabilities of CN¥5.84b due within 12 months and liabilities of CN¥2.51b due beyond that. On the other hand, it had cash of CN¥7.46b and CN¥2.34b worth of receivables due within a year. So it actually has CN¥1.46b more liquid assets than total liabilities.

This surplus suggests that Anhui Hengyuan Coal Industry and Electricity PowerLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Anhui Hengyuan Coal Industry and Electricity PowerLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Anhui Hengyuan Coal Industry and Electricity PowerLtd's load is not too heavy, because its EBIT was down 35% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Anhui Hengyuan Coal Industry and Electricity PowerLtd'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. Anhui Hengyuan Coal Industry and Electricity PowerLtd 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. Over the last three years, Anhui Hengyuan Coal Industry and Electricity PowerLtd recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Anhui Hengyuan Coal Industry and Electricity PowerLtd has net cash of CN¥5.50b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 91% of its EBIT. So we don't have any problem with Anhui Hengyuan Coal Industry and Electricity PowerLtd's use of debt. 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. For example, we've discovered 1 warning sign for Anhui Hengyuan Coal Industry and Electricity PowerLtd that you should be aware of before investing here.

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.