Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Huali Industrial Group Company Limited (SZSE:300979) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Huali Industrial Group's Debt?

As you can see below, Huali Industrial Group had CN¥528.8m of debt at September 2024, down from CN¥742.9m a year prior. But it also has CN¥7.73b in cash to offset that, meaning it has CN¥7.20b net cash.

A Look At Huali Industrial Group's Liabilities

The latest balance sheet data shows that Huali Industrial Group had liabilities of CN¥4.80b due within a year, and liabilities of CN¥598.3m falling due after that. Offsetting this, it had CN¥7.73b in cash and CN¥3.51b in receivables that were due within 12 months. So it can boast CN¥5.85b more liquid assets than total liabilities.

This surplus suggests that Huali Industrial Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Huali Industrial Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Huali Industrial Group has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Huali Industrial Group 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 Huali Industrial Group 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, Huali Industrial Group produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huali Industrial Group has CN¥7.20b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 27% over the last year. So is Huali Industrial Group's debt a risk? It doesn't seem so to us. 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 Huali Industrial Group .

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.