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.' 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. Importantly, Jiangsu Zeyu Intelligent Power Co.,Ltd. (SZSE:301179) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Jiangsu Zeyu Intelligent PowerLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Jiangsu Zeyu Intelligent PowerLtd had debt of CN¥532.7m, up from CN¥288.7m in one year. But it also has CN¥2.54b in cash to offset that, meaning it has CN¥2.01b net cash.

How Healthy Is Jiangsu Zeyu Intelligent PowerLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Zeyu Intelligent PowerLtd had liabilities of CN¥1.13b due within 12 months, and liabilities of CN¥1.72m due beyond 12 months. Offsetting this, it had CN¥2.54b in cash and CN¥295.0m in receivables that were due within 12 months. So it can boast CN¥1.71b more liquid assets than total liabilities.

It's good to see that Jiangsu Zeyu Intelligent PowerLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Jiangsu Zeyu Intelligent PowerLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Jiangsu Zeyu Intelligent PowerLtd if management cannot prevent a repeat of the 24% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jiangsu Zeyu Intelligent PowerLtd'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. Jiangsu Zeyu Intelligent PowerLtd 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 Zeyu Intelligent PowerLtd recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu Zeyu Intelligent PowerLtd has net cash of CN¥2.01b, as well as more liquid assets than liabilities. So we don't have any problem with Jiangsu Zeyu Intelligent PowerLtd's use of debt. 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 instance, we've identified 2 warning signs for Jiangsu Zeyu Intelligent PowerLtd (1 shouldn't be ignored) 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.