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. As with many other companies Shanghai M&G Stationery Inc. (SHSE:603899) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Shanghai M&G Stationery's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shanghai M&G Stationery had CN¥445.6m of debt, an increase on CN¥411.8m, over one year. But on the other hand it also has CN¥5.92b in cash, leading to a CN¥5.47b net cash position.

How Healthy Is Shanghai M&G Stationery's Balance Sheet?

The latest balance sheet data shows that Shanghai M&G Stationery had liabilities of CN¥5.31b due within a year, and liabilities of CN¥415.4m falling due after that. Offsetting these obligations, it had cash of CN¥5.92b as well as receivables valued at CN¥3.92b due within 12 months. So it can boast CN¥4.11b more liquid assets than total liabilities.

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

Also positive, Shanghai M&G Stationery grew its EBIT by 20% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai M&G Stationery's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Shanghai M&G Stationery 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, Shanghai M&G Stationery recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai M&G Stationery has CN¥5.47b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥2.3b, being 96% of its EBIT. So we don't think Shanghai M&G Stationery's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shanghai M&G Stationery has 1 warning sign we think you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com