Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Oriental Pearl Group Co.,Ltd. (SHSE:600637) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Oriental Pearl GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Oriental Pearl GroupLtd had debt of CN¥2.78b, up from CN¥2.31b in one year. But on the other hand it also has CN¥17.0b in cash, leading to a CN¥14.2b net cash position.

How Strong Is Oriental Pearl GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that Oriental Pearl GroupLtd had liabilities of CN¥8.45b falling due within a year, and liabilities of CN¥1.66b due beyond that. Offsetting these obligations, it had cash of CN¥17.0b as well as receivables valued at CN¥2.90b due within 12 months. So it actually has CN¥9.80b more liquid assets than total liabilities.

This surplus strongly suggests that Oriental Pearl GroupLtd has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Oriental Pearl GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Oriental Pearl GroupLtd grew its EBIT by 291% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Oriental Pearl GroupLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Oriental Pearl 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. In the last two years, Oriental Pearl GroupLtd's free cash flow amounted to 37% 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 Oriental Pearl GroupLtd has CN¥14.2b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 291% over the last year. So is Oriental Pearl GroupLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Oriental Pearl GroupLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.