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 note that Anhui Jinhe Industrial Co.,Ltd. (SZSE:002597) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Anhui Jinhe IndustrialLtd's Net Debt?

As you can see below, Anhui Jinhe IndustrialLtd had CN¥1.70b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥3.24b in cash, so it actually has CN¥1.54b net cash.

A Look At Anhui Jinhe IndustrialLtd's Liabilities

We can see from the most recent balance sheet that Anhui Jinhe IndustrialLtd had liabilities of CN¥1.84b falling due within a year, and liabilities of CN¥1.24b due beyond that. On the other hand, it had cash of CN¥3.24b and CN¥1.19b worth of receivables due within a year. So it actually has CN¥1.35b more liquid assets than total liabilities.

This short term liquidity is a sign that Anhui Jinhe IndustrialLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Anhui Jinhe IndustrialLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Anhui Jinhe IndustrialLtd if management cannot prevent a repeat of the 57% 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. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Anhui Jinhe IndustrialLtd can strengthen its balance sheet over time. 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. While Anhui Jinhe IndustrialLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Anhui Jinhe IndustrialLtd recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Anhui Jinhe IndustrialLtd has CN¥1.54b in net cash and a decent-looking balance sheet. So we are not troubled with Anhui Jinhe IndustrialLtd's debt use. 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. To that end, you should learn about the 3 warning signs we've spotted with Anhui Jinhe IndustrialLtd (including 1 which 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.