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.' 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 note that Anhui Gujing Distillery Co., Ltd. (SZSE:000596) 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?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Anhui Gujing Distillery Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Anhui Gujing Distillery had debt of CN¥207.0m, up from CN¥106.7m in one year. But on the other hand it also has CN¥17.3b in cash, leading to a CN¥17.1b net cash position.

How Healthy Is Anhui Gujing Distillery's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anhui Gujing Distillery had liabilities of CN¥15.4b due within 12 months and liabilities of CN¥607.9m due beyond that. Offsetting this, it had CN¥17.3b in cash and CN¥4.98b in receivables that were due within 12 months. So it can boast CN¥6.31b more liquid assets than total liabilities.

This short term liquidity is a sign that Anhui Gujing Distillery could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Anhui Gujing Distillery has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Anhui Gujing Distillery grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anhui Gujing Distillery'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. While Anhui Gujing Distillery 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. Over the most recent three years, Anhui Gujing Distillery recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Anhui Gujing Distillery has CN¥17.1b in net cash and a decent-looking balance sheet. And we liked the look of last year's 42% year-on-year EBIT growth. So is Anhui Gujing Distillery's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Anhui Gujing Distillery (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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