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 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. Importantly, Jiahe Foods Industry Co., Ltd. (SHSE:605300) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiahe Foods Industry's Debt?

You can click the graphic below for the historical numbers, but it shows that Jiahe Foods Industry had CN¥149.8m of debt in June 2024, down from CN¥723.3m, one year before. But it also has CN¥929.0m in cash to offset that, meaning it has CN¥779.3m net cash.

How Strong Is Jiahe Foods Industry's Balance Sheet?

The latest balance sheet data shows that Jiahe Foods Industry had liabilities of CN¥374.6m due within a year, and liabilities of CN¥72.1m falling due after that. On the other hand, it had cash of CN¥929.0m and CN¥233.4m worth of receivables due within a year. So it can boast CN¥715.7m more liquid assets than total liabilities.

This surplus suggests that Jiahe Foods Industry has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Jiahe Foods Industry has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Jiahe Foods Industry has seen its EBIT plunge 15% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Jiahe Foods Industry 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiahe Foods Industry 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. Looking at the most recent three years, Jiahe Foods Industry recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiahe Foods Industry has CN¥779.3m in net cash and a decent-looking balance sheet. So we don't have any problem with Jiahe Foods Industry'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. For example - Jiahe Foods Industry has 2 warning signs we think 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.