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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Tianneng Power International Limited (HKG:819) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Tianneng Power International

How Much Debt Does Tianneng Power International Carry?

The image below, which you can click on for greater detail, shows that at December 2021 Tianneng Power International had debt of CN¥4.28b, up from CN¥1.64b in one year. However, it does have CN¥11.3b in cash offsetting this, leading to net cash of CN¥7.00b.

How Healthy Is Tianneng Power International's Balance Sheet?

We can see from the most recent balance sheet that Tianneng Power International had liabilities of CN¥15.3b falling due within a year, and liabilities of CN¥2.07b due beyond that. Offsetting this, it had CN¥11.3b in cash and CN¥2.40b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.67b.

Tianneng Power International has a market capitalization of CN¥6.25b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Tianneng Power International also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Tianneng Power International's load is not too heavy, because its EBIT was down 59% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Tianneng Power 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Tianneng Power International 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. Looking at the most recent three years, Tianneng Power International recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Tianneng Power International'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¥7.00b. So although we see some areas for improvement, we're not too worried about Tianneng Power International's balance sheet. 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. To that end, you should be aware of the 3 warning signs we've spotted with Tianneng Power International .

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.