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. Importantly, CCCC Design & Consulting Group Co., Ltd. (SHSE:600720) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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 CCCC Design & Consulting Group's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 CCCC Design & Consulting Group had debt of CN¥1.09b, up from CN¥201.3m in one year. However, its balance sheet shows it holds CN¥5.33b in cash, so it actually has CN¥4.24b net cash.

A Look At CCCC Design & Consulting Group's Liabilities

The latest balance sheet data shows that CCCC Design & Consulting Group had liabilities of CN¥10.9b due within a year, and liabilities of CN¥3.12b falling due after that. Offsetting these obligations, it had cash of CN¥5.33b as well as receivables valued at CN¥10.7b due within 12 months. So it actually has CN¥1.98b more liquid assets than total liabilities.

This short term liquidity is a sign that CCCC Design & Consulting Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, CCCC Design & Consulting Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that CCCC Design & Consulting Group grew its EBIT at 13% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if CCCC Design & Consulting Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CCCC Design & Consulting Group 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. In the last three years, CCCC Design & Consulting Group created free cash flow amounting to 16% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that CCCC Design & Consulting Group has net cash of CN¥4.24b, as well as more liquid assets than liabilities. And it also grew its EBIT by 13% over the last year. So we don't have any problem with CCCC Design & Consulting Group'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 example, we've discovered 3 warning signs for CCCC Design & Consulting Group (2 are concerning!) that you should be aware of before investing here.

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.

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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