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.' 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. We can see that Jiangsu Jiangnan Water Co., Ltd. (SHSE:601199) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Jiangsu Jiangnan Water's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Jiangsu Jiangnan Water had CN¥701.5m of debt, an increase on CN¥600.4m, over one year. But on the other hand it also has CN¥759.6m in cash, leading to a CN¥58.2m net cash position.

How Strong Is Jiangsu Jiangnan Water's Balance Sheet?

The latest balance sheet data shows that Jiangsu Jiangnan Water had liabilities of CN¥1.20b due within a year, and liabilities of CN¥1.15b falling due after that. Offsetting these obligations, it had cash of CN¥759.6m as well as receivables valued at CN¥558.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.03b.

Since publicly traded Jiangsu Jiangnan Water shares are worth a total of CN¥5.58b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Jiangsu Jiangnan Water also has more cash than debt, so we're pretty confident it can manage its debt safely.

While Jiangsu Jiangnan Water doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Jiangsu Jiangnan Water's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Jiangsu Jiangnan Water 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. Looking at the most recent three years, Jiangsu Jiangnan Water recorded free cash flow of 37% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Jiangsu Jiangnan Water's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥58.2m. So we don't have any problem with Jiangsu Jiangnan Water'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. Case in point: We've spotted 1 warning sign for Jiangsu Jiangnan Water you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.