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. We can see that Qingdao East Steel Tower Stock Co.Ltd (SZSE:002545) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Qingdao East Steel Tower StockLtd's Net Debt?

As you can see below, Qingdao East Steel Tower StockLtd had CN¥1.70b of debt at March 2024, down from CN¥2.01b a year prior. However, its balance sheet shows it holds CN¥2.64b in cash, so it actually has CN¥940.6m net cash.

How Strong Is Qingdao East Steel Tower StockLtd's Balance Sheet?

We can see from the most recent balance sheet that Qingdao East Steel Tower StockLtd had liabilities of CN¥2.58b falling due within a year, and liabilities of CN¥1.81b due beyond that. Offsetting this, it had CN¥2.64b in cash and CN¥964.1m in receivables that were due within 12 months. So its liabilities total CN¥777.2m more than the combination of its cash and short-term receivables.

Since publicly traded Qingdao East Steel Tower StockLtd shares are worth a total of CN¥7.69b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Qingdao East Steel Tower StockLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Qingdao East Steel Tower StockLtd if management cannot prevent a repeat of the 25% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Qingdao East Steel Tower StockLtd 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. While Qingdao East Steel Tower StockLtd 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. During the last three years, Qingdao East Steel Tower StockLtd produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Qingdao East Steel Tower StockLtd does have more liabilities than liquid assets, it also has net cash of CN¥940.6m. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥1.1b. So we are not troubled with Qingdao East Steel Tower StockLtd's debt use. 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. For instance, we've identified 2 warning signs for Qingdao East Steel Tower StockLtd that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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