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, Bear Electric Appliance Co.,Ltd. (SZSE:002959) does carry debt. But should shareholders be worried about its use of debt?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Bear Electric ApplianceLtd's Debt?

The chart below, which you can click on for greater detail, shows that Bear Electric ApplianceLtd had CN¥495.9m in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥2.60b in cash, leading to a CN¥2.11b net cash position.

A Look At Bear Electric ApplianceLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Bear Electric ApplianceLtd had liabilities of CN¥1.81b due within 12 months and liabilities of CN¥488.9m due beyond that. Offsetting these obligations, it had cash of CN¥2.60b as well as receivables valued at CN¥172.5m due within 12 months. So it can boast CN¥477.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Bear Electric ApplianceLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Bear Electric ApplianceLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Bear Electric ApplianceLtd if management cannot prevent a repeat of the 28% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Bear Electric ApplianceLtd's ability to maintain a healthy balance sheet going forward. 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. Bear Electric ApplianceLtd 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, Bear Electric ApplianceLtd's free cash flow amounted to 35% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Bear Electric ApplianceLtd has CN¥2.11b in net cash and a decent-looking balance sheet. So we don't have any problem with Bear Electric ApplianceLtd'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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Bear Electric ApplianceLtd (of which 1 is a bit unpleasant!) you should know about.

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.