Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies ZJLD Group Inc (HKG:6979) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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, 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 ZJLD Group's Net Debt?

As you can see below, at the end of June 2024, ZJLD Group had CN¥285.1m of debt, up from CN¥36.6m a year ago. Click the image for more detail. However, it does have CN¥6.11b in cash offsetting this, leading to net cash of CN¥5.83b.

How Healthy Is ZJLD Group's Balance Sheet?

According to the last reported balance sheet, ZJLD Group had liabilities of CN¥4.82b due within 12 months, and liabilities of CN¥42.8m due beyond 12 months. On the other hand, it had cash of CN¥6.11b and CN¥331.6m worth of receivables due within a year. So it actually has CN¥1.58b more liquid assets than total liabilities.

This short term liquidity is a sign that ZJLD Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that ZJLD Group has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that ZJLD Group grew its EBIT by 18% last year, making its debt load easier to handle. 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 ZJLD Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While ZJLD Group 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. Over the last three years, ZJLD Group saw substantial negative free cash flow, in total. 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 ZJLD Group has net cash of CN¥5.83b, as well as more liquid assets than liabilities. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't have any problem with ZJLD Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for ZJLD Group you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.