Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that MeiHua Holdings Group Co.,Ltd (SHSE:600873) does use debt in its business. But is this debt a concern to shareholders?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is MeiHua Holdings GroupLtd's Net Debt?

As you can see below, MeiHua Holdings GroupLtd had CN¥3.82b of debt at September 2024, down from CN¥4.08b a year prior. However, it does have CN¥5.65b in cash offsetting this, leading to net cash of CN¥1.84b.

How Healthy Is MeiHua Holdings GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MeiHua Holdings GroupLtd had liabilities of CN¥7.27b due within 12 months and liabilities of CN¥1.55b due beyond that. Offsetting this, it had CN¥5.65b in cash and CN¥821.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.34b more than its cash and near-term receivables, combined.

Since publicly traded MeiHua Holdings GroupLtd shares are worth a total of CN¥29.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, MeiHua Holdings GroupLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the bad news is that MeiHua Holdings GroupLtd has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine MeiHua Holdings GroupLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. MeiHua Holdings GroupLtd 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. Over the last three years, MeiHua Holdings GroupLtd recorded free cash flow worth a fulsome 94% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

We could understand if investors are concerned about MeiHua Holdings GroupLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥1.84b. And it impressed us with free cash flow of CN¥2.7b, being 94% of its EBIT. So we don't have any problem with MeiHua Holdings GroupLtd'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. For instance, we've identified 1 warning sign for MeiHua Holdings GroupLtd that you should be aware of.

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.