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.' 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 Qingdao Sentury Tire Co., Ltd. (SZSE:002984) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Qingdao Sentury Tire's Debt?

The chart below, which you can click on for greater detail, shows that Qingdao Sentury Tire had CN¥1.98b in debt in March 2024; about the same as the year before. But on the other hand it also has CN¥3.66b in cash, leading to a CN¥1.69b net cash position.

How Healthy Is Qingdao Sentury Tire's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qingdao Sentury Tire had liabilities of CN¥1.71b due within 12 months and liabilities of CN¥2.12b due beyond that. On the other hand, it had cash of CN¥3.66b and CN¥1.26b worth of receivables due within a year. So it can boast CN¥1.10b more liquid assets than total liabilities.

This surplus suggests that Qingdao Sentury Tire has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Qingdao Sentury Tire has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Qingdao Sentury Tire grew its EBIT by 102% last year, which is an impressive improvement. 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 ultimately the future profitability of the business will decide if Qingdao Sentury Tire 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Qingdao Sentury Tire 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, Qingdao Sentury Tire reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Qingdao Sentury Tire has CN¥1.69b in net cash and a decent-looking balance sheet. And we liked the look of last year's 102% year-on-year EBIT growth. So is Qingdao Sentury Tire's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Qingdao Sentury Tire that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.