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. We can see that BTG Hotels (Group) Co., Ltd. (SHSE:600258) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is BTG Hotels (Group)'s Net Debt?

The image below, which you can click on for greater detail, shows that BTG Hotels (Group) had debt of CN¥746.3m at the end of June 2024, a reduction from CN¥1.10b over a year. But it also has CN¥2.86b in cash to offset that, meaning it has CN¥2.12b net cash.

A Look At BTG Hotels (Group)'s Liabilities

The latest balance sheet data shows that BTG Hotels (Group) had liabilities of CN¥4.79b due within a year, and liabilities of CN¥9.03b falling due after that. Offsetting these obligations, it had cash of CN¥2.86b as well as receivables valued at CN¥660.7m due within 12 months. So it has liabilities totalling CN¥10.3b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of CN¥12.7b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, BTG Hotels (Group) also has more cash than debt, so we're pretty confident it can manage its debt safely.

Pleasingly, BTG Hotels (Group) is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 146% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BTG Hotels (Group) can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. BTG Hotels (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. Over the last two years, BTG Hotels (Group) actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While BTG Hotels (Group) does have more liabilities than liquid assets, it also has net cash of CN¥2.12b. The cherry on top was that in converted 249% of that EBIT to free cash flow, bringing in CN¥2.9b. So we don't have any problem with BTG Hotels (Group)'s use of debt. 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. Be aware that BTG Hotels (Group) is showing 1 warning sign in our investment analysis , you should know about...

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.