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. Importantly, Changhong Meiling Co., Ltd. (SZSE:000521) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Changhong Meiling Carry?

You can click the graphic below for the historical numbers, but it shows that Changhong Meiling had CN¥1.15b of debt in September 2024, down from CN¥1.24b, one year before. However, it does have CN¥10.1b in cash offsetting this, leading to net cash of CN¥8.94b.

How Healthy Is Changhong Meiling's Balance Sheet?

We can see from the most recent balance sheet that Changhong Meiling had liabilities of CN¥15.9b falling due within a year, and liabilities of CN¥301.6m due beyond that. Offsetting these obligations, it had cash of CN¥10.1b as well as receivables valued at CN¥3.91b due within 12 months. So its liabilities total CN¥2.20b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Changhong Meiling is worth CN¥8.00b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Changhong Meiling boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Changhong Meiling has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 Changhong Meiling 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Changhong Meiling 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. Happily for any shareholders, Changhong Meiling actually produced more free cash flow than EBIT over the last two years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Changhong Meiling does have more liabilities than liquid assets, it also has net cash of CN¥8.94b. And it impressed us with free cash flow of CN¥2.1b, being 346% of its EBIT. So we don't think Changhong Meiling's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Changhong Meiling's dividend history, without delay!

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.