The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Jiangsu Sanfame Polyester Material Co.,Ltd. (SHSE:600370) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Jiangsu Sanfame Polyester MaterialLtd

What Is Jiangsu Sanfame Polyester MaterialLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Jiangsu Sanfame Polyester MaterialLtd had CN¥1.21b of debt in March 2022, down from CN¥2.27b, one year before. But it also has CN¥1.97b in cash to offset that, meaning it has CN¥763.0m net cash.

How Strong Is Jiangsu Sanfame Polyester MaterialLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Sanfame Polyester MaterialLtd had liabilities of CN¥4.80b due within 12 months, and liabilities of CN¥695.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.97b as well as receivables valued at CN¥2.81b due within 12 months. So it has liabilities totalling CN¥720.5m more than its cash and near-term receivables, combined.

Of course, Jiangsu Sanfame Polyester MaterialLtd has a market capitalization of CN¥13.0b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Jiangsu Sanfame Polyester MaterialLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Jiangsu Sanfame Polyester MaterialLtd grew its EBIT at 12% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu Sanfame Polyester MaterialLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Jiangsu Sanfame Polyester MaterialLtd 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, Jiangsu Sanfame Polyester MaterialLtd 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 it is always sensible to look at a company's total liabilities, it is very reassuring that Jiangsu Sanfame Polyester MaterialLtd has CN¥763.0m in net cash. And it impressed us with free cash flow of -CN¥477m, being 162% of its EBIT. So is Jiangsu Sanfame Polyester MaterialLtd'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. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Jiangsu Sanfame Polyester MaterialLtd (including 1 which is potentially serious) .

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.