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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Haier Smart Home Co., Ltd. (SHSE:600690) 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 and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Haier Smart Home's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Haier Smart Home had CN¥30.1b of debt, an increase on CN¥27.8b, over one year. But on the other hand it also has CN¥57.3b in cash, leading to a CN¥27.3b net cash position.

How Healthy Is Haier Smart Home's Balance Sheet?

The latest balance sheet data shows that Haier Smart Home had liabilities of CN¥125.6b due within a year, and liabilities of CN¥28.1b falling due after that. On the other hand, it had cash of CN¥57.3b and CN¥34.0b worth of receivables due within a year. So it has liabilities totalling CN¥62.4b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Haier Smart Home has a huge market capitalization of CN¥275.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Haier Smart Home also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Haier Smart Home grew its EBIT by 17% last year, making its debt load easier 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 Haier Smart Home'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. Haier Smart Home 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 three years, Haier Smart Home recorded free cash flow worth a fulsome 84% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

Although Haier Smart Home's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥27.3b. And it impressed us with free cash flow of CN¥16b, being 84% of its EBIT. So we don't think Haier Smart Home's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Haier Smart Home's earnings per share history for free.

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.