Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies BAIC Motor Corporation Limited (HKG:1958) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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 BAIC Motor

What Is BAIC Motor's Net Debt?

As you can see below, BAIC Motor had CN¥20.0b of debt at June 2022, down from CN¥24.1b a year prior. But it also has CN¥37.9b in cash to offset that, meaning it has CN¥17.9b net cash.

How Strong Is BAIC Motor's Balance Sheet?

We can see from the most recent balance sheet that BAIC Motor had liabilities of CN¥87.5b falling due within a year, and liabilities of CN¥13.5b due beyond that. Offsetting these obligations, it had cash of CN¥37.9b as well as receivables valued at CN¥20.0b due within 12 months. So it has liabilities totalling CN¥43.2b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥14.1b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. 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.

It is just as well that BAIC Motor's load is not too heavy, because its EBIT was down 23% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BAIC Motor 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 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. Over the most recent three years, BAIC Motor recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although BAIC Motor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥17.9b. Despite the cash, we do find BAIC Motor's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. Case in point: We've spotted 1 warning sign for BAIC Motor 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.