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. As with many other companies Shanxi Huaxiang Group Co., Ltd. (SHSE:603112) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shanxi Huaxiang Group's Debt?

As you can see below, at the end of September 2024, Shanxi Huaxiang Group had CN¥1.52b of debt, up from CN¥1.28b a year ago. Click the image for more detail. But it also has CN¥1.67b in cash to offset that, meaning it has CN¥153.3m net cash.

A Look At Shanxi Huaxiang Group's Liabilities

The latest balance sheet data shows that Shanxi Huaxiang Group had liabilities of CN¥911.8m due within a year, and liabilities of CN¥1.68b falling due after that. Offsetting this, it had CN¥1.67b in cash and CN¥1.30b in receivables that were due within 12 months. So it can boast CN¥375.1m more liquid assets than total liabilities.

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

On top of that, Shanxi Huaxiang Group grew its EBIT by 42% 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 ultimately the future profitability of the business will decide if Shanxi Huaxiang Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shanxi Huaxiang Group 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. In the last three years, Shanxi Huaxiang Group created free cash flow amounting to 17% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanxi Huaxiang Group has net cash of CN¥153.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 42% over the last year. So we don't think Shanxi Huaxiang Group's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Shanxi Huaxiang Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.