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.' 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. Importantly, Jiangsu Linyang Energy Co., Ltd. (SHSE:601222) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Jiangsu Linyang Energy

What Is Jiangsu Linyang Energy's Debt?

As you can see below, Jiangsu Linyang Energy had CN¥3.58b of debt at March 2022, down from CN¥6.58b a year prior. However, its balance sheet shows it holds CN¥4.88b in cash, so it actually has CN¥1.30b net cash.

A Look At Jiangsu Linyang Energy's Liabilities

We can see from the most recent balance sheet that Jiangsu Linyang Energy had liabilities of CN¥3.23b falling due within a year, and liabilities of CN¥2.32b due beyond that. Offsetting these obligations, it had cash of CN¥4.88b as well as receivables valued at CN¥4.50b due within 12 months. So it actually has CN¥3.82b more liquid assets than total liabilities.

This excess liquidity suggests that Jiangsu Linyang Energy is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Jiangsu Linyang Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Jiangsu Linyang Energy saw its EBIT decline by 9.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Jiangsu Linyang Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiangsu Linyang Energy 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, Jiangsu Linyang Energy recorded free cash flow of 46% 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 Jiangsu Linyang Energy has CN¥1.30b in net cash and a decent-looking balance sheet. So we are not troubled with Jiangsu Linyang Energy's debt use. 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. Case in point: We've spotted 2 warning signs for Jiangsu Linyang Energy 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.