David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Harbin Hatou Investment Co.,Ltd (SHSE:600864) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Harbin Hatou InvestmentLtd

What Is Harbin Hatou InvestmentLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Harbin Hatou InvestmentLtd had CN¥14.6b of debt in September 2023, down from CN¥15.6b, one year before. But it also has CN¥18.1b in cash to offset that, meaning it has CN¥3.51b net cash.

How Healthy Is Harbin Hatou InvestmentLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Harbin Hatou InvestmentLtd had liabilities of CN¥16.8b due within 12 months and liabilities of CN¥5.78b due beyond that. Offsetting these obligations, it had cash of CN¥18.1b as well as receivables valued at CN¥6.64b due within 12 months. So it actually has CN¥2.12b more liquid assets than total liabilities.

This excess liquidity suggests that Harbin Hatou InvestmentLtd is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Harbin Hatou InvestmentLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

One way Harbin Hatou InvestmentLtd could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 16%, as it did over the last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Harbin Hatou InvestmentLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Harbin Hatou InvestmentLtd 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. Happily for any shareholders, Harbin Hatou InvestmentLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Harbin Hatou InvestmentLtd has net cash of CN¥3.51b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 530% of its EBIT. So we don't think Harbin Hatou InvestmentLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Harbin Hatou InvestmentLtd you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.