Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Weifu High-Technology Group Co., Ltd. (SZSE:000581) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Weifu High-Technology Group's Net Debt?

As you can see below, Weifu High-Technology Group had CN¥651.8m of debt at September 2024, down from CN¥1.74b a year prior. However, it does have CN¥4.74b in cash offsetting this, leading to net cash of CN¥4.08b.

How Strong Is Weifu High-Technology Group's Balance Sheet?

We can see from the most recent balance sheet that Weifu High-Technology Group had liabilities of CN¥7.02b falling due within a year, and liabilities of CN¥515.7m due beyond that. Offsetting these obligations, it had cash of CN¥4.74b as well as receivables valued at CN¥6.35b due within 12 months. So it actually has CN¥3.55b more liquid assets than total liabilities.

This excess liquidity suggests that Weifu High-Technology Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Weifu High-Technology Group boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Weifu High-Technology Group turned things around in the last 12 months, delivering and EBIT of CN¥420m. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Weifu High-Technology Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Weifu High-Technology Group 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 year, Weifu High-Technology Group generated free cash flow amounting to a very robust 85% 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 Weifu High-Technology Group has net cash of CN¥4.08b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥355m, being 85% of its EBIT. So is Weifu High-Technology Group's debt a risk? It doesn't seem so to us. 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. For example Weifu High-Technology Group has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.