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. We note that Henan Pinggao Electric Co.,Ltd. (SHSE:600312) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Henan Pinggao ElectricLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Henan Pinggao ElectricLtd had CN¥172.1m of debt in March 2024, down from CN¥314.1m, one year before. However, its balance sheet shows it holds CN¥5.07b in cash, so it actually has CN¥4.90b net cash.

A Look At Henan Pinggao ElectricLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Henan Pinggao ElectricLtd had liabilities of CN¥9.50b due within 12 months and liabilities of CN¥157.4m due beyond that. On the other hand, it had cash of CN¥5.07b and CN¥7.54b worth of receivables due within a year. So it can boast CN¥2.96b more liquid assets than total liabilities.

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

Even more impressive was the fact that Henan Pinggao ElectricLtd grew its EBIT by 148% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Henan Pinggao ElectricLtd'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. Henan Pinggao ElectricLtd 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. Happily for any shareholders, Henan Pinggao ElectricLtd 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 Henan Pinggao ElectricLtd has net cash of CN¥4.90b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.5b, being 288% of its EBIT. So is Henan Pinggao ElectricLtd'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. We've identified 1 warning sign with Henan Pinggao ElectricLtd , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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