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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, BAIC Motor Corporation Limited (HKG:1958) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for BAIC Motor

How Much Debt Does BAIC Motor Carry?

You can click the graphic below for the historical numbers, but it shows that BAIC Motor had CN¥13.8b of debt in September 2022, down from CN¥19.6b, one year before. But it also has CN¥42.0b in cash to offset that, meaning it has CN¥28.2b net cash.

A Look At BAIC Motor's Liabilities

The latest balance sheet data shows that BAIC Motor had liabilities of CN¥83.1b due within a year, and liabilities of CN¥15.1b falling due after that. Offsetting these obligations, it had cash of CN¥42.0b as well as receivables valued at CN¥20.5b due within 12 months. So its liabilities total CN¥35.6b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥14.9b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, BAIC Motor would probably need a major re-capitalization if its creditors were to demand repayment. Given that BAIC Motor has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

And we also note warmly that BAIC Motor grew its EBIT by 10% last year, making its debt load easier to handle. 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 BAIC Motor's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While BAIC Motor 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. During the last three years, BAIC Motor produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While BAIC Motor does have more liabilities than liquid assets, it also has net cash of CN¥28.2b. On top of that, it increased its EBIT by 10% in the last twelve months. So although we see some areas for improvement, we're not too worried about BAIC Motor's balance sheet. 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. For example, we've discovered 1 warning sign for BAIC Motor that you should be aware of before investing here.

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.

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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.