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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Hainan Strait Shipping Co.,Ltd. (SZSE:002320) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Hainan Strait ShippingLtd Carry?

The chart below, which you can click on for greater detail, shows that Hainan Strait ShippingLtd had CN¥431.8m in debt in June 2024; about the same as the year before. However, its balance sheet shows it holds CN¥1.74b in cash, so it actually has CN¥1.31b net cash.

How Strong Is Hainan Strait ShippingLtd's Balance Sheet?

The latest balance sheet data shows that Hainan Strait ShippingLtd had liabilities of CN¥746.9m due within a year, and liabilities of CN¥652.4m falling due after that. Offsetting these obligations, it had cash of CN¥1.74b as well as receivables valued at CN¥340.4m due within 12 months. So it actually has CN¥678.3m more liquid assets than total liabilities.

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

On top of that, Hainan Strait ShippingLtd grew its EBIT by 30% 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 ultimately the future profitability of the business will decide if Hainan Strait ShippingLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Hainan Strait ShippingLtd 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 three years, Hainan Strait ShippingLtd generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hainan Strait ShippingLtd has net cash of CN¥1.31b, as well as more liquid assets than liabilities. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in CN¥1.4b. So we don't think Hainan Strait ShippingLtd's use of debt is risky. 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 Hainan Strait ShippingLtd is showing 1 warning sign in our investment analysis , you should know about...

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.