The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Guangdong Meiyanjixiang Hydropower Co.,Ltd. (SHSE:600868) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangdong Meiyanjixiang HydropowerLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Guangdong Meiyanjixiang HydropowerLtd had CN¥99.1m of debt in September 2024, down from CN¥133.0m, one year before. But it also has CN¥551.0m in cash to offset that, meaning it has CN¥451.8m net cash.

How Healthy Is Guangdong Meiyanjixiang HydropowerLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Meiyanjixiang HydropowerLtd had liabilities of CN¥293.0m falling due within a year, and liabilities of CN¥389.8m due beyond that. Offsetting these obligations, it had cash of CN¥551.0m as well as receivables valued at CN¥434.6m due within 12 months. So it can boast CN¥302.8m more liquid assets than total liabilities.

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

Importantly, Guangdong Meiyanjixiang HydropowerLtd's EBIT fell a jaw-dropping 93% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Guangdong Meiyanjixiang HydropowerLtd 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. While Guangdong Meiyanjixiang HydropowerLtd 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. Over the last three years, Guangdong Meiyanjixiang HydropowerLtd recorded free cash flow worth a fulsome 92% 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

While it is always sensible to investigate a company's debt, in this case Guangdong Meiyanjixiang HydropowerLtd has CN¥451.8m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥77m, being 92% of its EBIT. So we don't have any problem with Guangdong Meiyanjixiang HydropowerLtd's use of debt. 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 - Guangdong Meiyanjixiang HydropowerLtd has 1 warning sign we think you should be aware of.

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.