David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Minsheng Education Group Company Limited (HKG:1569) does carry 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Minsheng Education Group

How Much Debt Does Minsheng Education Group Carry?

As you can see below, at the end of December 2021, Minsheng Education Group had CN¥1.98b of debt, up from CN¥1.83b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥2.95b in cash, so it actually has CN¥975.7m net cash.

How Healthy Is Minsheng Education Group's Balance Sheet?

The latest balance sheet data shows that Minsheng Education Group had liabilities of CN¥3.32b due within a year, and liabilities of CN¥3.33b falling due after that. Offsetting this, it had CN¥2.95b in cash and CN¥606.0m in receivables that were due within 12 months. So it has liabilities totalling CN¥3.09b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's CN¥2.33b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Given that Minsheng Education Group 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.

In addition to that, we're happy to report that Minsheng Education Group has boosted its EBIT by 70%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Minsheng Education Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Minsheng Education Group 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. In the last three years, Minsheng Education Group's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

Although Minsheng Education Group'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¥975.7m. And it impressed us with its EBIT growth of 70% over the last year. So we don't have any problem with Minsheng Education Group's use of debt. 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. We've identified 2 warning signs with Minsheng Education Group , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.