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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Qinghai Huzhu TianYouDe Highland Barley Spirit Co., Ltd. (SZSE:002646) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Qinghai Huzhu TianYouDe Highland Barley Spirit's Net Debt?

As you can see below, Qinghai Huzhu TianYouDe Highland Barley Spirit had CN¥109.4m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥451.6m in cash, leading to a CN¥342.1m net cash position.

How Healthy Is Qinghai Huzhu TianYouDe Highland Barley Spirit's Balance Sheet?

We can see from the most recent balance sheet that Qinghai Huzhu TianYouDe Highland Barley Spirit had liabilities of CN¥452.3m falling due within a year, and liabilities of CN¥41.1m due beyond that. Offsetting these obligations, it had cash of CN¥451.6m as well as receivables valued at CN¥28.8m due within 12 months. So its liabilities total CN¥13.1m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Qinghai Huzhu TianYouDe Highland Barley Spirit's 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¥4.73b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Qinghai Huzhu TianYouDe Highland Barley Spirit boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Qinghai Huzhu TianYouDe Highland Barley Spirit grew its EBIT by 98% 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 ultimately the future profitability of the business will decide if Qinghai Huzhu TianYouDe Highland Barley Spirit 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 company can only pay off debt with cold hard cash, not accounting profits. Qinghai Huzhu TianYouDe Highland Barley Spirit 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. Over the last three years, Qinghai Huzhu TianYouDe Highland Barley Spirit 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Qinghai Huzhu TianYouDe Highland Barley Spirit has CN¥342.1m in net cash. And it impressed us with its EBIT growth of 98% over the last year. So we don't have any problem with Qinghai Huzhu TianYouDe Highland Barley Spirit'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. For example, we've discovered 1 warning sign for Qinghai Huzhu TianYouDe Highland Barley Spirit that you should be aware of before investing here.

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.