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.' 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 note that Ronglian Group Ltd. (SZSE:002642) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ronglian Group

How Much Debt Does Ronglian Group Carry?

As you can see below, at the end of March 2022, Ronglian Group had CN¥292.2m of debt, up from CN¥155.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥400.6m in cash, so it actually has CN¥108.4m net cash.

How Strong Is Ronglian Group's Balance Sheet?

According to the last reported balance sheet, Ronglian Group had liabilities of CN¥1.45b due within 12 months, and liabilities of CN¥26.4m due beyond 12 months. On the other hand, it had cash of CN¥400.6m and CN¥1.01b worth of receivables due within a year. So its liabilities total CN¥65.3m more than the combination of its cash and short-term receivables.

Having regard to Ronglian Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥4.03b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Ronglian Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Ronglian Group turned things around in the last 12 months, delivering and EBIT of CN¥53m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Ronglian Group'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 Ronglian Group 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 last year, Ronglian Group reported free cash flow worth 12% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Ronglian Group has CN¥108.4m in net cash. So we don't have any problem with Ronglian 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. To that end, you should be aware of the 1 warning sign we've spotted with Ronglian Group .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.