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.' 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 can see that Sichuan Zigong Conveying Machine Group Co., Ltd. (SZSE:001288) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Sichuan Zigong Conveying Machine Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Sichuan Zigong Conveying Machine Group had CN¥664.3m of debt, an increase on CN¥546.7m, over one year. But on the other hand it also has CN¥1.45b in cash, leading to a CN¥787.1m net cash position.

How Healthy Is Sichuan Zigong Conveying Machine Group's Balance Sheet?

The latest balance sheet data shows that Sichuan Zigong Conveying Machine Group had liabilities of CN¥1.10b due within a year, and liabilities of CN¥746.2m falling due after that. Offsetting these obligations, it had cash of CN¥1.45b as well as receivables valued at CN¥1.47b due within 12 months. So it can boast CN¥1.07b more liquid assets than total liabilities.

This surplus suggests that Sichuan Zigong Conveying Machine Group is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sichuan Zigong Conveying Machine Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Sichuan Zigong Conveying Machine Group grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sichuan Zigong Conveying Machine Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Sichuan Zigong Conveying Machine Group 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. During the last three years, Sichuan Zigong Conveying Machine Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Zigong Conveying Machine Group has net cash of CN¥787.1m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 50% over the last year. So we don't have any problem with Sichuan Zigong Conveying Machine Group's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sichuan Zigong Conveying Machine Group is showing 2 warning signs in our investment analysis , and 1 of those is significant...

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.