Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Zhejiang Huangma Technology Co.,Ltd (SHSE:603181) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

View our latest analysis for Zhejiang Huangma TechnologyLtd

How Much Debt Does Zhejiang Huangma TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Zhejiang Huangma TechnologyLtd had debt of CN¥428.9m, up from CN¥145.1m in one year. However, its balance sheet shows it holds CN¥739.0m in cash, so it actually has CN¥310.1m net cash.

How Strong Is Zhejiang Huangma TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Huangma TechnologyLtd had liabilities of CN¥461.7m due within a year, and liabilities of CN¥427.8m falling due after that. On the other hand, it had cash of CN¥739.0m and CN¥411.1m worth of receivables due within a year. So it can boast CN¥260.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang Huangma TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang Huangma TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Zhejiang Huangma TechnologyLtd has been able to increase its EBIT by 24% in twelve months, making it easier to pay down 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 Zhejiang Huangma TechnologyLtd'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. Zhejiang Huangma TechnologyLtd 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. Over the last three years, Zhejiang Huangma TechnologyLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While it is always sensible to investigate a company's debt, in this case Zhejiang Huangma TechnologyLtd has CN¥310.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 24% over the last year. So we are not troubled with Zhejiang Huangma TechnologyLtd's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Zhejiang Huangma TechnologyLtd (of which 1 is significant!) you should know about.

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.