David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Anhui Quanchai Engine Co., Ltd. (SHSE:600218) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Anhui Quanchai Engine

What Is Anhui Quanchai Engine's Debt?

As you can see below, Anhui Quanchai Engine had CN¥24.0m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥1.79b in cash to offset that, meaning it has CN¥1.77b net cash.

How Healthy Is Anhui Quanchai Engine's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Anhui Quanchai Engine had liabilities of CN¥2.77b due within 12 months and liabilities of CN¥174.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.79b as well as receivables valued at CN¥2.23b due within 12 months. So it can boast CN¥1.07b more liquid assets than total liabilities.

This luscious liquidity implies that Anhui Quanchai Engine's balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Anhui Quanchai Engine has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Anhui Quanchai Engine has seen its EBIT plunge 16% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Anhui Quanchai Engine 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Anhui Quanchai Engine 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, Anhui Quanchai Engine actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Anhui Quanchai Engine has net cash of CN¥1.77b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥114m, being 161% of its EBIT. So we don't think Anhui Quanchai Engine's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Anhui Quanchai Engine has 4 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.