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.' 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 Namchow Food Group (Shanghai) Co., Ltd. (SHSE:605339) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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. 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.

How Much Debt Does Namchow Food Group (Shanghai) Carry?

You can click the graphic below for the historical numbers, but it shows that Namchow Food Group (Shanghai) had CN¥251.5m of debt in September 2024, down from CN¥320.2m, one year before. However, its balance sheet shows it holds CN¥1.59b in cash, so it actually has CN¥1.34b net cash.

How Strong Is Namchow Food Group (Shanghai)'s Balance Sheet?

According to the last reported balance sheet, Namchow Food Group (Shanghai) had liabilities of CN¥759.6m due within 12 months, and liabilities of CN¥60.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.59b as well as receivables valued at CN¥192.1m due within 12 months. So it actually has CN¥961.5m more liquid assets than total liabilities.

This surplus suggests that Namchow Food Group (Shanghai) has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Namchow Food Group (Shanghai) boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Namchow Food Group (Shanghai) grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Namchow Food Group (Shanghai)'s earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Namchow Food Group (Shanghai) 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 most recent three years, Namchow Food Group (Shanghai) recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Namchow Food Group (Shanghai) has CN¥1.34b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 77% over the last year. So we don't think Namchow Food Group (Shanghai)'s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Namchow Food Group (Shanghai) (at least 1 which is concerning) , and understanding them should be part of your investment process.

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.