David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Inner Mongolia ERDOS Resources Co.,Ltd. (SHSE:900936) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Inner Mongolia ERDOS ResourcesLtd

What Is Inner Mongolia ERDOS ResourcesLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Inner Mongolia ERDOS ResourcesLtd had CN¥8.19b of debt in March 2023, down from CN¥10.3b, one year before. However, it does have CN¥6.07b in cash offsetting this, leading to net debt of about CN¥2.13b.

How Strong Is Inner Mongolia ERDOS ResourcesLtd's Balance Sheet?

According to the last reported balance sheet, Inner Mongolia ERDOS ResourcesLtd had liabilities of CN¥16.2b due within 12 months, and liabilities of CN¥5.79b due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.07b as well as receivables valued at CN¥2.53b due within 12 months. So it has liabilities totalling CN¥13.4b more than its cash and near-term receivables, combined.

Inner Mongolia ERDOS ResourcesLtd has a market capitalization of CN¥24.7b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Inner Mongolia ERDOS ResourcesLtd has net debt of just 0.24 times EBITDA, suggesting it could ramp leverage without breaking a sweat. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So there's no doubt this company can take on debt while staying cool as a cucumber. It is just as well that Inner Mongolia ERDOS ResourcesLtd's load is not too heavy, because its EBIT was down 37% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Inner Mongolia ERDOS ResourcesLtd'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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Inner Mongolia ERDOS ResourcesLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Based on what we've seen Inner Mongolia ERDOS ResourcesLtd is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. There's no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. Considering this range of data points, we think Inner Mongolia ERDOS ResourcesLtd is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Inner Mongolia ERDOS ResourcesLtd has 1 warning sign we think you should be aware of.

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.