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.' 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 Yantai Changyu Pioneer Wine Company Limited (SZSE:000869) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Yantai Changyu Pioneer Wine's Net Debt?

As you can see below, Yantai Changyu Pioneer Wine had CN¥376.2m of debt at September 2024, down from CN¥540.5m a year prior. But on the other hand it also has CN¥1.63b in cash, leading to a CN¥1.25b net cash position.

How Strong Is Yantai Changyu Pioneer Wine's Balance Sheet?

According to the last reported balance sheet, Yantai Changyu Pioneer Wine had liabilities of CN¥1.46b due within 12 months, and liabilities of CN¥161.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.63b as well as receivables valued at CN¥463.2m due within 12 months. So it can boast CN¥475.1m 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!

It is just as well that Yantai Changyu Pioneer Wine's load is not too heavy, because its EBIT was down 35% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Yantai Changyu Pioneer Wine's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Yantai Changyu Pioneer Wine may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Yantai Changyu Pioneer Wine actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Yantai Changyu Pioneer Wine has CN¥1.25b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 124% of that EBIT to free cash flow, bringing in CN¥500m. So we don't have any problem with Yantai Changyu Pioneer Wine's use of debt. 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. Be aware that Yantai Changyu Pioneer Wine is showing 2 warning signs in our investment analysis , you should know about...

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.