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 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. We can see that Oriental Pearl Group Co.,Ltd. (SHSE:600637) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Oriental Pearl GroupLtd's Net Debt?

As you can see below, at the end of March 2024, Oriental Pearl GroupLtd had CN¥3.16b of debt, up from CN¥2.28b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥18.3b in cash, so it actually has CN¥15.2b net cash.

How Strong Is Oriental Pearl GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Oriental Pearl GroupLtd had liabilities of CN¥7.75b falling due within a year, and liabilities of CN¥1.98b due beyond that. On the other hand, it had cash of CN¥18.3b and CN¥2.61b worth of receivables due within a year. So it actually has CN¥11.2b more liquid assets than total liabilities.

This surplus strongly suggests that Oriental Pearl GroupLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Oriental Pearl GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Oriental Pearl GroupLtd turned things around in the last 12 months, delivering and EBIT of CN¥529m. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Oriental Pearl GroupLtd 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 company can only pay off debt with cold hard cash, not accounting profits. Oriental Pearl GroupLtd 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. During the last year, Oriental Pearl GroupLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Oriental Pearl GroupLtd has CN¥15.2b in net cash and a decent-looking balance sheet. So we don't have any problem with Oriental Pearl GroupLtd'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. We've identified 2 warning signs with Oriental Pearl GroupLtd (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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