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. As with many other companies Chongqing Changan Automobile Company Limited (SZSE:000625) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

What Is Chongqing Changan Automobile's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Chongqing Changan Automobile had debt of CN¥1.21b, up from CN¥1.13b in one year. However, it does have CN¥70.2b in cash offsetting this, leading to net cash of CN¥69.0b.

How Strong Is Chongqing Changan Automobile's Balance Sheet?

We can see from the most recent balance sheet that Chongqing Changan Automobile had liabilities of CN¥101.9b falling due within a year, and liabilities of CN¥12.9b due beyond that. Offsetting these obligations, it had cash of CN¥70.2b as well as receivables valued at CN¥38.5b due within 12 months. So it has liabilities totalling CN¥6.09b more than its cash and near-term receivables, combined.

Since publicly traded Chongqing Changan Automobile shares are worth a very impressive total of CN¥103.3b, 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. Despite its noteworthy liabilities, Chongqing Changan Automobile boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Chongqing Changan Automobile's EBIT was down 63% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Chongqing Changan Automobile'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 Chongqing Changan Automobile 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, Chongqing Changan Automobile actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Chongqing Changan Automobile has CN¥69.0b in net cash. The cherry on top was that in converted 317% of that EBIT to free cash flow, bringing in CN¥19b. So we don't have any problem with Chongqing Changan Automobile's use of debt. 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 3 warning signs we've spotted with Chongqing Changan Automobile .

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.