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.' 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. As with many other companies Ligao Foods Co.,Ltd. (SZSE:300973) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Ligao FoodsLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Ligao FoodsLtd had CN¥1.00b of debt, an increase on CN¥830.3m, over one year. However, it does have CN¥1.09b in cash offsetting this, leading to net cash of CN¥85.8m.

A Look At Ligao FoodsLtd's Liabilities

According to the last reported balance sheet, Ligao FoodsLtd had liabilities of CN¥609.5m due within 12 months, and liabilities of CN¥871.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.09b as well as receivables valued at CN¥333.6m due within 12 months. So it has liabilities totalling CN¥59.2m more than its cash and near-term receivables, combined.

This state of affairs indicates that Ligao FoodsLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥6.12b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Ligao FoodsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Ligao FoodsLtd's saving grace is its low debt levels, because its EBIT has tanked 44% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Ligao FoodsLtd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Ligao FoodsLtd 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 last three years, Ligao FoodsLtd saw substantial negative free cash flow, in total. 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 Ligao FoodsLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥85.8m. So although we see some areas for improvement, we're not too worried about Ligao FoodsLtd's balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Ligao FoodsLtd has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.