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 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 Sichuan Lutianhua Company Limited By Shares (SZSE:000912) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Sichuan Lutianhua Company Limited By Shares's Debt?

The image below, which you can click on for greater detail, shows that Sichuan Lutianhua Company Limited By Shares had debt of CN¥471.6m at the end of September 2024, a reduction from CN¥566.2m over a year. However, it does have CN¥3.99b in cash offsetting this, leading to net cash of CN¥3.52b.

How Healthy Is Sichuan Lutianhua Company Limited By Shares' Balance Sheet?

The latest balance sheet data shows that Sichuan Lutianhua Company Limited By Shares had liabilities of CN¥3.57b due within a year, and liabilities of CN¥492.1m falling due after that. On the other hand, it had cash of CN¥3.99b and CN¥173.6m worth of receivables due within a year. So it actually has CN¥105.8m more liquid assets than total liabilities.

Having regard to Sichuan Lutianhua Company Limited By Shares' size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥7.37b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Sichuan Lutianhua Company Limited By Shares boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sichuan Lutianhua Company Limited By Shares's saving grace is its low debt levels, because its EBIT has tanked 71% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sichuan Lutianhua Company Limited By Shares will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sichuan Lutianhua Company Limited By Shares 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, Sichuan Lutianhua Company Limited By Shares actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Lutianhua Company Limited By Shares has net cash of CN¥3.52b, as well as more liquid assets than liabilities. The cherry on top was that in converted 215% of that EBIT to free cash flow, bringing in CN¥272m. So we don't have any problem with Sichuan Lutianhua Company Limited By Shares'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 - Sichuan Lutianhua Company Limited By Shares has 2 warning signs we think 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.