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. Importantly, Shandong Weigao Group Medical Polymer Company Limited (HKG:1066) does carry debt. 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. If things get really bad, the lenders can take control of the business. 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 Shandong Weigao Group Medical Polymer

What Is Shandong Weigao Group Medical Polymer's Net Debt?

The chart below, which you can click on for greater detail, shows that Shandong Weigao Group Medical Polymer had CN¥4.37b in debt in June 2022; about the same as the year before. But on the other hand it also has CN¥7.15b in cash, leading to a CN¥2.78b net cash position.

How Strong Is Shandong Weigao Group Medical Polymer's Balance Sheet?

According to the last reported balance sheet, Shandong Weigao Group Medical Polymer had liabilities of CN¥5.91b due within 12 months, and liabilities of CN¥4.41b due beyond 12 months. Offsetting this, it had CN¥7.15b in cash and CN¥7.06b in receivables that were due within 12 months. So it can boast CN¥3.89b more liquid assets than total liabilities.

This surplus suggests that Shandong Weigao Group Medical Polymer has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Shandong Weigao Group Medical Polymer has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Shandong Weigao Group Medical Polymer grew its EBIT by 13% last year, making its debt load easier to handle. 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 Shandong Weigao Group Medical Polymer'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shandong Weigao Group Medical Polymer 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. During the last three years, Shandong Weigao Group Medical Polymer produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shandong Weigao Group Medical Polymer has CN¥2.78b in net cash and a decent-looking balance sheet. So is Shandong Weigao Group Medical Polymer's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Shandong Weigao Group Medical Polymer, you may well want to click here to check an interactive graph of its earnings per share history.

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.