Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Shanghai Ziyan Foods Co., Ltd. (SHSE:603057) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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 Shanghai Ziyan Foods's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shanghai Ziyan Foods had CN¥369.6m of debt, an increase on none, over one year. But on the other hand it also has CN¥1.28b in cash, leading to a CN¥909.8m net cash position.

A Look At Shanghai Ziyan Foods' Liabilities

We can see from the most recent balance sheet that Shanghai Ziyan Foods had liabilities of CN¥946.6m falling due within a year, and liabilities of CN¥239.8m due beyond that. Offsetting this, it had CN¥1.28b in cash and CN¥181.0m in receivables that were due within 12 months. So it can boast CN¥273.9m more liquid assets than total liabilities.

This surplus suggests that Shanghai Ziyan Foods has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shanghai Ziyan Foods has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Shanghai Ziyan Foods grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Ziyan Foods'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, a company can only pay off debt with cold hard cash, not accounting profits. Shanghai Ziyan Foods 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 Ziyan Foods generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd 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 Shanghai Ziyan Foods has net cash of CN¥909.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥212m. So is Shanghai Ziyan Foods'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, we've discovered 1 warning sign for Shanghai Ziyan Foods that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.