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.' 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 Maoyan Entertainment (HKG:1896) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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.

Check out our latest analysis for Maoyan Entertainment

What Is Maoyan Entertainment's Debt?

As you can see below, Maoyan Entertainment had CN¥597.0m of debt at December 2021, down from CN¥1.06b a year prior. But it also has CN¥2.66b in cash to offset that, meaning it has CN¥2.07b net cash.

How Strong Is Maoyan Entertainment's Balance Sheet?

We can see from the most recent balance sheet that Maoyan Entertainment had liabilities of CN¥2.91b falling due within a year, and liabilities of CN¥132.0m due beyond that. Offsetting these obligations, it had cash of CN¥2.66b as well as receivables valued at CN¥1.08b due within 12 months. So it can boast CN¥702.5m more liquid assets than total liabilities.

This surplus suggests that Maoyan Entertainment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Maoyan Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Maoyan Entertainment made a loss at the EBIT level, last year, it was also good to see that it generated CN¥787m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Maoyan Entertainment 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Maoyan Entertainment 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 year, Maoyan Entertainment produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Maoyan Entertainment has net cash of CN¥2.07b, as well as more liquid assets than liabilities. The cherry on top was that in converted 71% of that EBIT to free cash flow, bringing in CN¥560m. So is Maoyan Entertainment's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Maoyan Entertainment that 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.