Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Yunnan Baiyao Group Co.,Ltd (SZSE:000538) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Yunnan Baiyao GroupLtd's Net Debt?

As you can see below, at the end of June 2024, Yunnan Baiyao GroupLtd had CN¥2.15b of debt, up from CN¥1.58b a year ago. Click the image for more detail. However, it does have CN¥16.9b in cash offsetting this, leading to net cash of CN¥14.8b.

How Strong Is Yunnan Baiyao GroupLtd's Balance Sheet?

According to the last reported balance sheet, Yunnan Baiyao GroupLtd had liabilities of CN¥13.8b due within 12 months, and liabilities of CN¥1.18b due beyond 12 months. On the other hand, it had cash of CN¥16.9b and CN¥12.5b worth of receivables due within a year. So it can boast CN¥14.5b more liquid assets than total liabilities.

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

But the other side of the story is that Yunnan Baiyao GroupLtd saw its EBIT decline by 4.7% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Yunnan Baiyao GroupLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Yunnan Baiyao GroupLtd 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, Yunnan Baiyao GroupLtd generated free cash flow amounting to a very robust 86% 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 Yunnan Baiyao GroupLtd has net cash of CN¥14.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 86% of that EBIT to free cash flow, bringing in CN¥4.0b. So is Yunnan Baiyao GroupLtd's debt a risk? It doesn't seem so to us. 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. Be aware that Yunnan Baiyao GroupLtd is showing 1 warning sign in our investment analysis , 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.