Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Ligao Foods Co.,Ltd. (SZSE:300973) makes use of debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Ligao FoodsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Ligao FoodsLtd had CN¥937.5m of debt, an increase on CN¥775.1m, over one year. But it also has CN¥1.17b in cash to offset that, meaning it has CN¥228.8m net cash.

How Strong Is Ligao FoodsLtd's Balance Sheet?

The latest balance sheet data shows that Ligao FoodsLtd had liabilities of CN¥480.7m due within a year, and liabilities of CN¥905.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.17b as well as receivables valued at CN¥300.4m due within 12 months. So it can boast CN¥80.9m more liquid assets than total liabilities.

This state of affairs indicates that Ligao FoodsLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥4.72b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Ligao FoodsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Ligao FoodsLtd's load is not too heavy, because its EBIT was down 41% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Ligao FoodsLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ligao FoodsLtd 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. Over the last three years, Ligao FoodsLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Ligao FoodsLtd has net cash of CN¥228.8m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Ligao FoodsLtd's balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Ligao FoodsLtd has 3 warning signs we think you should be aware of.

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.

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