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. As with many other companies Shanghai Fengyuzhu Culture Technology Co., Ltd. (SHSE:603466) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Shanghai Fengyuzhu Culture Technology Carry?
The chart below, which you can click on for greater detail, shows that Shanghai Fengyuzhu Culture Technology had CN¥503.0m in debt in March 2024; about the same as the year before. However, it does have CN¥1.82b in cash offsetting this, leading to net cash of CN¥1.31b.
How Strong Is Shanghai Fengyuzhu Culture Technology's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Fengyuzhu Culture Technology had liabilities of CN¥1.71b due within 12 months and liabilities of CN¥551.5m due beyond that. Offsetting these obligations, it had cash of CN¥1.82b as well as receivables valued at CN¥1.71b due within 12 months. So it can boast CN¥1.26b more liquid assets than total liabilities.
This excess liquidity suggests that Shanghai Fengyuzhu Culture Technology is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Shanghai Fengyuzhu Culture Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that Shanghai Fengyuzhu Culture Technology grew its EBIT by 212% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Fengyuzhu Culture Technology'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. While Shanghai Fengyuzhu Culture Technology 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, Shanghai Fengyuzhu Culture Technology recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Summing Up
While it is always sensible to investigate a company's debt, in this case Shanghai Fengyuzhu Culture Technology has CN¥1.31b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in -CN¥17m. When it comes to Shanghai Fengyuzhu Culture Technology's debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. For example - Shanghai Fengyuzhu Culture Technology has 1 warning sign we think you should be aware of.
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.