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.' 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 China Ruyi Holdings Limited (HKG:136) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is China Ruyi Holdings's Debt?

The chart below, which you can click on for greater detail, shows that China Ruyi Holdings had CN¥1.88b in debt in June 2024; about the same as the year before. However, it does have CN¥2.95b in cash offsetting this, leading to net cash of CN¥1.07b.

A Look At China Ruyi Holdings' Liabilities

The latest balance sheet data shows that China Ruyi Holdings had liabilities of CN¥4.48b due within a year, and liabilities of CN¥2.24b falling due after that. On the other hand, it had cash of CN¥2.95b and CN¥4.10b worth of receivables due within a year. So it actually has CN¥330.4m more liquid assets than total liabilities.

This state of affairs indicates that China Ruyi Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥24.7b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, China Ruyi Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Although China Ruyi Holdings made a loss at the EBIT level, last year, it was also good to see that it generated CN¥2.3b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if China Ruyi Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While China Ruyi Holdings 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. Looking at the most recent year, China Ruyi Holdings recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Ruyi Holdings has CN¥1.07b in net cash and a decent-looking balance sheet. So we are not troubled with China Ruyi Holdings's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for China Ruyi Holdings 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.