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 can see that Sichuan Mingxing Electric Power Co., Ltd. (SHSE:600101) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Sichuan Mingxing Electric Power's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Sichuan Mingxing Electric Power had CN¥80.0m of debt, an increase on CN¥50.0m, over one year. But on the other hand it also has CN¥895.1m in cash, leading to a CN¥815.1m net cash position.

How Strong Is Sichuan Mingxing Electric Power's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sichuan Mingxing Electric Power had liabilities of CN¥904.0m due within 12 months and liabilities of CN¥301.0m due beyond that. On the other hand, it had cash of CN¥895.1m and CN¥164.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥145.0m.

Since publicly traded Sichuan Mingxing Electric Power shares are worth a total of CN¥4.37b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sichuan Mingxing Electric Power also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Sichuan Mingxing Electric Power if management cannot prevent a repeat of the 23% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sichuan Mingxing Electric Power will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sichuan Mingxing Electric Power 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. Considering the last three years, Sichuan Mingxing Electric Power actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

We could understand if investors are concerned about Sichuan Mingxing Electric Power's liabilities, but we can be reassured by the fact it has has net cash of CN¥815.1m. So we are not troubled with Sichuan Mingxing Electric Power's debt use. 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. For example, we've discovered 2 warning signs for Sichuan Mingxing Electric Power that you should be aware of before investing here.

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.