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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Songcheng Performance Development Co.,Ltd (SZSE:300144) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Songcheng Performance DevelopmentLtd Carry?

As you can see below, Songcheng Performance DevelopmentLtd had CN¥143.1m of debt at March 2024, down from CN¥291.3m a year prior. However, its balance sheet shows it holds CN¥3.45b in cash, so it actually has CN¥3.31b net cash.

A Look At Songcheng Performance DevelopmentLtd's Liabilities

The latest balance sheet data shows that Songcheng Performance DevelopmentLtd had liabilities of CN¥785.0m due within a year, and liabilities of CN¥779.7m falling due after that. On the other hand, it had cash of CN¥3.45b and CN¥29.7m worth of receivables due within a year. So it actually has CN¥1.92b more liquid assets than total liabilities.

This surplus suggests that Songcheng Performance DevelopmentLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Songcheng Performance DevelopmentLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Songcheng Performance DevelopmentLtd made a loss at the EBIT level, last year, it was also good to see that it generated CN¥1.2b in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Songcheng Performance DevelopmentLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Songcheng Performance DevelopmentLtd 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, Songcheng Performance DevelopmentLtd recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Songcheng Performance DevelopmentLtd has net cash of CN¥3.31b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.2b, being 96% of its EBIT. So is Songcheng Performance DevelopmentLtd's debt a risk? It doesn't seem so to us. 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. We've identified 3 warning signs with Songcheng Performance DevelopmentLtd , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.