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. As with many other companies Shanghai Aladdin Biochemical Technology Co.,Ltd. (SHSE:688179) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shanghai Aladdin Biochemical TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shanghai Aladdin Biochemical TechnologyLtd had debt of CN¥423.8m, up from CN¥337.4m in one year. However, its balance sheet shows it holds CN¥539.1m in cash, so it actually has CN¥115.4m net cash.

A Look At Shanghai Aladdin Biochemical TechnologyLtd's Liabilities

We can see from the most recent balance sheet that Shanghai Aladdin Biochemical TechnologyLtd had liabilities of CN¥209.1m falling due within a year, and liabilities of CN¥407.8m due beyond that. Offsetting this, it had CN¥539.1m in cash and CN¥68.1m in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

Having regard to Shanghai Aladdin Biochemical TechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥4.15b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shanghai Aladdin Biochemical TechnologyLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Shanghai Aladdin Biochemical TechnologyLtd grew its EBIT by 73% 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 future earnings, more than anything, that will determine Shanghai Aladdin Biochemical TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shanghai Aladdin Biochemical TechnologyLtd 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, Shanghai Aladdin Biochemical TechnologyLtd 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

We could understand if investors are concerned about Shanghai Aladdin Biochemical TechnologyLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥115.4m. And it impressed us with its EBIT growth of 73% over the last year. So we don't have any problem with Shanghai Aladdin Biochemical TechnologyLtd's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Shanghai Aladdin Biochemical TechnologyLtd 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.