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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Yantai Changyu Pioneer Wine Company Limited (SZSE:000869) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Yantai Changyu Pioneer Wine's Net Debt?

The image below, which you can click on for greater detail, shows that Yantai Changyu Pioneer Wine had debt of CN¥446.4m at the end of March 2024, a reduction from CN¥639.8m over a year. However, its balance sheet shows it holds CN¥2.06b in cash, so it actually has CN¥1.61b net cash.

A Look At Yantai Changyu Pioneer Wine's Liabilities

The latest balance sheet data shows that Yantai Changyu Pioneer Wine had liabilities of CN¥1.56b due within a year, and liabilities of CN¥175.6m falling due after that. On the other hand, it had cash of CN¥2.06b and CN¥711.0m worth of receivables due within a year. So it actually has CN¥1.03b more liquid assets than total liabilities.

This short term liquidity is a sign that Yantai Changyu Pioneer Wine could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Yantai Changyu Pioneer Wine boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Yantai Changyu Pioneer Wine saw its EBIT drop by 4.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Yantai Changyu Pioneer Wine can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 last three years, Yantai Changyu Pioneer Wine actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yantai Changyu Pioneer Wine has CN¥1.61b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥640m, being 119% of its EBIT. So we don't think Yantai Changyu Pioneer Wine's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Yantai Changyu Pioneer Wine .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.