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 can see that CoCreation Grass Co., Ltd (SHSE:605099) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is CoCreation Grass's Debt?

You can click the graphic below for the historical numbers, but it shows that CoCreation Grass had CN¥105.3m of debt in September 2024, down from CN¥300.0m, one year before. However, it does have CN¥934.9m in cash offsetting this, leading to net cash of CN¥829.5m.

A Look At CoCreation Grass' Liabilities

Zooming in on the latest balance sheet data, we can see that CoCreation Grass had liabilities of CN¥417.1m due within 12 months and liabilities of CN¥26.9m due beyond that. On the other hand, it had cash of CN¥934.9m and CN¥662.0m worth of receivables due within a year. So it can boast CN¥1.15b more liquid assets than total liabilities.

This surplus suggests that CoCreation Grass has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that CoCreation Grass has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that CoCreation Grass has increased its EBIT by 6.1% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if CoCreation Grass can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. CoCreation Grass 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 three years, CoCreation Grass produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case CoCreation Grass has CN¥829.5m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥304m, being 74% of its EBIT. So is CoCreation Grass'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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for CoCreation Grass you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.