Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, CIMC Vehicles (Group) Co., Ltd. (SZSE:301039) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

How Much Debt Does CIMC Vehicles (Group) Carry?

The image below, which you can click on for greater detail, shows that at March 2024 CIMC Vehicles (Group) had debt of CN¥895.2m, up from CN¥826.5m in one year. However, its balance sheet shows it holds CN¥6.54b in cash, so it actually has CN¥5.65b net cash.

How Strong Is CIMC Vehicles (Group)'s Balance Sheet?

We can see from the most recent balance sheet that CIMC Vehicles (Group) had liabilities of CN¥8.50b falling due within a year, and liabilities of CN¥626.4m due beyond that. On the other hand, it had cash of CN¥6.54b and CN¥5.33b worth of receivables due within a year. So it can boast CN¥2.75b more liquid assets than total liabilities.

This excess liquidity suggests that CIMC Vehicles (Group) is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that CIMC Vehicles (Group) has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that CIMC Vehicles (Group) has increased its EBIT by 4.1% over twelve months, which should ease any concerns about debt repayment. 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 CIMC Vehicles (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 company can only pay off debt with cold hard cash, not accounting profits. CIMC Vehicles (Group) 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. In the last three years, CIMC Vehicles (Group)'s free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case CIMC Vehicles (Group) has CN¥5.65b in net cash and a decent-looking balance sheet. And it also grew its EBIT by 4.1% over the last year. So is CIMC Vehicles (Group)'s debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with CIMC Vehicles (Group) .

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