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. Importantly, Hangzhou Haoyue Personal Care Co., Ltd (SHSE:605009) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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.

How Much Debt Does Hangzhou Haoyue Personal Care Carry?

As you can see below, at the end of June 2024, Hangzhou Haoyue Personal Care had CN¥335.2m of debt, up from CN¥300.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.51b in cash, so it actually has CN¥1.18b net cash.

How Strong Is Hangzhou Haoyue Personal Care's Balance Sheet?

According to the last reported balance sheet, Hangzhou Haoyue Personal Care had liabilities of CN¥1.08b due within 12 months, and liabilities of CN¥144.6m due beyond 12 months. Offsetting this, it had CN¥1.51b in cash and CN¥206.6m in receivables that were due within 12 months. So it actually has CN¥498.0m more liquid assets than total liabilities.

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

The good news is that Hangzhou Haoyue Personal Care has increased its EBIT by 6.0% over twelve months, which should ease any concerns about debt repayment. 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 Hangzhou Haoyue Personal Care's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hangzhou Haoyue Personal Care 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 most recent three years, Hangzhou Haoyue Personal Care recorded free cash flow worth 50% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hangzhou Haoyue Personal Care has CN¥1.18b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 6.0% over the last year. So is Hangzhou Haoyue Personal Care's debt a risk? It doesn't seem so to us. 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 Hangzhou Haoyue Personal Care has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.