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.' 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 361 Degrees International Limited (HKG:1361) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does 361 Degrees International Carry?

The chart below, which you can click on for greater detail, shows that 361 Degrees International had CN¥292.5m in debt in December 2023; about the same as the year before. However, its balance sheet shows it holds CN¥5.20b in cash, so it actually has CN¥4.91b net cash.

A Look At 361 Degrees International's Liabilities

We can see from the most recent balance sheet that 361 Degrees International had liabilities of CN¥3.09b falling due within a year, and liabilities of CN¥254.0m due beyond that. Offsetting these obligations, it had cash of CN¥5.20b as well as receivables valued at CN¥3.91b due within 12 months. So it actually has CN¥5.76b more liquid assets than total liabilities.

This surplus strongly suggests that 361 Degrees International has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that 361 Degrees International has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, 361 Degrees International grew its EBIT by 30% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 361 Degrees International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 361 Degrees International 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. Looking at the most recent three years, 361 Degrees International recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case 361 Degrees International has CN¥4.91b in net cash and a decent-looking balance sheet. And we liked the look of last year's 30% year-on-year EBIT growth. So we don't think 361 Degrees International's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that 361 Degrees International is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.