The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Yantai Changyu Pioneer Wine Company Limited (SZSE:200869) does use debt in its business. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Yantai Changyu Pioneer Wine

What Is Yantai Changyu Pioneer Wine's Net Debt?

As you can see below, Yantai Changyu Pioneer Wine had CN¥713.0m of debt at June 2022, down from CN¥1.01b a year prior. But it also has CN¥1.90b in cash to offset that, meaning it has CN¥1.19b net cash.

How Healthy Is Yantai Changyu Pioneer Wine's Balance Sheet?

We can see from the most recent balance sheet that Yantai Changyu Pioneer Wine had liabilities of CN¥2.23b falling due within a year, and liabilities of CN¥336.3m due beyond that. On the other hand, it had cash of CN¥1.90b and CN¥531.1m worth of receivables due within a year. So it has liabilities totalling CN¥133.4m more than its cash and near-term receivables, combined.

Having regard to Yantai Changyu Pioneer Wine's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥15.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Yantai Changyu Pioneer Wine also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Yantai Changyu Pioneer Wine saw its EBIT drop by 2.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Yantai Changyu Pioneer Wine'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Yantai Changyu Pioneer Wine 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, Yantai Changyu Pioneer Wine recorded free cash flow worth 78% 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 look at a company's total liabilities, it is very reassuring that Yantai Changyu Pioneer Wine has CN¥1.19b in net cash. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥1.1b. So we don't think Yantai Changyu Pioneer Wine's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Yantai Changyu Pioneer Wine you should know about.

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.