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 can see that Sichuan Gold Co., Ltd. (SZSE:001337) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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, 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.

What Is Sichuan Gold's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sichuan Gold had debt of CN¥44.2m, up from none in one year. However, its balance sheet shows it holds CN¥692.1m in cash, so it actually has CN¥648.0m net cash.

How Strong Is Sichuan Gold's Balance Sheet?

The latest balance sheet data shows that Sichuan Gold had liabilities of CN¥174.3m due within a year, and liabilities of CN¥281.2m falling due after that. Offsetting these obligations, it had cash of CN¥692.1m as well as receivables valued at CN¥13.7m due within 12 months. So it actually has CN¥250.4m more liquid assets than total liabilities.

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

On top of that, Sichuan Gold grew its EBIT by 47% 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 you can't view debt in total isolation; since Sichuan Gold will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Sichuan Gold has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sichuan Gold produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sichuan Gold has CN¥648.0m in net cash and a decent-looking balance sheet. And we liked the look of last year's 47% year-on-year EBIT growth. So is Sichuan Gold's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Sichuan Gold has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.