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. As with many other companies Pacific Basin Shipping Limited (HKG:2343) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Pacific Basin Shipping

How Much Debt Does Pacific Basin Shipping Carry?

The image below, which you can click on for greater detail, shows that Pacific Basin Shipping had debt of US$447.5m at the end of June 2022, a reduction from US$771.6m over a year. But on the other hand it also has US$516.3m in cash, leading to a US$68.8m net cash position.

How Strong Is Pacific Basin Shipping's Balance Sheet?

We can see from the most recent balance sheet that Pacific Basin Shipping had liabilities of US$417.3m falling due within a year, and liabilities of US$430.5m due beyond that. On the other hand, it had cash of US$516.3m and US$179.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$151.9m.

Since publicly traded Pacific Basin Shipping shares are worth a total of US$1.78b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Pacific Basin Shipping also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Pacific Basin Shipping grew its EBIT by 395% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pacific Basin Shipping 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 Pacific Basin Shipping 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, Pacific Basin Shipping generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

We could understand if investors are concerned about Pacific Basin Shipping's liabilities, but we can be reassured by the fact it has has net cash of US$68.8m. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$996m. So is Pacific Basin Shipping'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 example Pacific Basin Shipping has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.