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 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 can see that East Group Co.,Ltd (SZSE:300376) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

How Much Debt Does East GroupLtd Carry?

You can click the graphic below for the historical numbers, but it shows that East GroupLtd had CN¥1.83b of debt in September 2023, down from CN¥2.72b, one year before. But on the other hand it also has CN¥2.08b in cash, leading to a CN¥251.8m net cash position.

How Healthy Is East GroupLtd's Balance Sheet?

We can see from the most recent balance sheet that East GroupLtd had liabilities of CN¥3.35b falling due within a year, and liabilities of CN¥3.14b due beyond that. On the other hand, it had cash of CN¥2.08b and CN¥4.53b worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

Having regard to East GroupLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥13.8b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that East GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Sadly, East GroupLtd's EBIT actually dropped 8.2% in the last year. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if East GroupLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. East GroupLtd 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, East GroupLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that East GroupLtd has net cash of CN¥251.8m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.0b, being 125% of its EBIT. So we are not troubled with East GroupLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - East GroupLtd has 1 warning sign we think 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.

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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.