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.' 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 Shanxi Coal International Energy Group Co.,Ltd (SHSE:600546) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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 Shanxi Coal International Energy GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Shanxi Coal International Energy GroupLtd had debt of CN¥8.56b, up from CN¥6.40b in one year. However, its balance sheet shows it holds CN¥9.28b in cash, so it actually has CN¥717.9m net cash.

How Healthy Is Shanxi Coal International Energy GroupLtd's Balance Sheet?

According to the last reported balance sheet, Shanxi Coal International Energy GroupLtd had liabilities of CN¥11.5b due within 12 months, and liabilities of CN¥11.7b due beyond 12 months. On the other hand, it had cash of CN¥9.28b and CN¥542.0m worth of receivables due within a year. So it has liabilities totalling CN¥13.3b more than its cash and near-term receivables, combined.

Shanxi Coal International Energy GroupLtd has a market capitalization of CN¥26.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Shanxi Coal International Energy GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Shanxi Coal International Energy GroupLtd if management cannot prevent a repeat of the 55% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Shanxi Coal International Energy GroupLtd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shanxi Coal International Energy GroupLtd 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 most recent three years, Shanxi Coal International Energy GroupLtd recorded free cash flow worth 73% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Shanxi Coal International Energy GroupLtd does have more liabilities than liquid assets, it also has net cash of CN¥717.9m. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in CN¥2.5b. So we are not troubled with Shanxi Coal International Energy GroupLtd's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Shanxi Coal International Energy GroupLtd has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.