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.' 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. We note that Haier Smart Home Co., Ltd. (SHSE:600690) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Haier Smart Home

How Much Debt Does Haier Smart Home Carry?

The image below, which you can click on for greater detail, shows that at June 2022 Haier Smart Home had debt of CN¥24.8b, up from CN¥23.6b in one year. However, it does have CN¥54.4b in cash offsetting this, leading to net cash of CN¥29.6b.

How Strong Is Haier Smart Home's Balance Sheet?

We can see from the most recent balance sheet that Haier Smart Home had liabilities of CN¥127.7b falling due within a year, and liabilities of CN¥11.4b due beyond that. On the other hand, it had cash of CN¥54.4b and CN¥29.1b worth of receivables due within a year. So it has liabilities totalling CN¥55.5b more than its cash and near-term receivables, combined.

Haier Smart Home has a very large market capitalization of CN¥225.9b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Haier Smart Home boasts net cash, so it's fair to say it does not have a heavy debt load!

Haier Smart Home's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Haier Smart Home'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Haier Smart Home 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. In the last three years, Haier Smart Home's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While Haier Smart Home does have more liabilities than liquid assets, it also has net cash of CN¥29.6b. So we don't have any problem with Haier Smart Home's use of debt. 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. Case in point: We've spotted 2 warning signs for Haier Smart Home you should be aware of, and 1 of them is significant.

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.