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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Wuxi Taiji Industry Limited Corporation (SHSE:600667) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Wuxi Taiji Industry Limited Carry?

As you can see below, Wuxi Taiji Industry Limited had CN¥4.85b of debt at March 2024, down from CN¥5.99b a year prior. However, it does have CN¥6.54b in cash offsetting this, leading to net cash of CN¥1.69b.

How Healthy Is Wuxi Taiji Industry Limited's Balance Sheet?

We can see from the most recent balance sheet that Wuxi Taiji Industry Limited had liabilities of CN¥20.4b falling due within a year, and liabilities of CN¥1.99b due beyond that. On the other hand, it had cash of CN¥6.54b and CN¥13.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.75b.

While this might seem like a lot, it is not so bad since Wuxi Taiji Industry Limited has a market capitalization of CN¥11.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Wuxi Taiji Industry Limited boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Wuxi Taiji Industry Limited turned things around in the last 12 months, delivering and EBIT of CN¥974m. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Wuxi Taiji Industry Limited's ability to maintain a healthy balance sheet going forward. 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. Wuxi Taiji Industry Limited 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 year, Wuxi Taiji Industry Limited actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Wuxi Taiji Industry Limited does have more liabilities than liquid assets, it also has net cash of CN¥1.69b. The cherry on top was that in converted 261% of that EBIT to free cash flow, bringing in CN¥2.5b. So we don't think Wuxi Taiji Industry Limited's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Wuxi Taiji Industry Limited , and understanding them should be part of your investment process.

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