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.' 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. We can see that Dalian Huarui Heavy Industry Group Co., LTD. (SZSE:002204) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does Dalian Huarui Heavy Industry Group Carry?

As you can see below, Dalian Huarui Heavy Industry Group had CN¥1.50b of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥3.18b in cash, leading to a CN¥1.68b net cash position.

How Healthy Is Dalian Huarui Heavy Industry Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dalian Huarui Heavy Industry Group had liabilities of CN¥16.2b due within 12 months and liabilities of CN¥1.92b due beyond that. Offsetting these obligations, it had cash of CN¥3.18b as well as receivables valued at CN¥8.67b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.28b.

This is a mountain of leverage relative to its market capitalization of CN¥9.24b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Dalian Huarui Heavy Industry Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Dalian Huarui Heavy Industry Group grew its EBIT at 19% over the last year, further increasing its ability to manage debt. 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 Dalian Huarui Heavy Industry Group's ability to maintain a healthy balance sheet going forward. 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. Dalian Huarui Heavy Industry Group 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. During the last three years, Dalian Huarui Heavy Industry Group burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While Dalian Huarui Heavy Industry Group does have more liabilities than liquid assets, it also has net cash of CN¥1.68b. And it impressed us with its EBIT growth of 19% over the last year. So we don't have any problem with Dalian Huarui Heavy Industry Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Dalian Huarui Heavy Industry Group 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.