The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shanghai Foreign Service Holding Group CO.,Ltd. (SHSE:600662) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shanghai Foreign Service Holding GroupLtd

What Is Shanghai Foreign Service Holding GroupLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Shanghai Foreign Service Holding GroupLtd had CN¥1.01b of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥11.1b in cash, so it actually has CN¥10.1b net cash.

A Look At Shanghai Foreign Service Holding GroupLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Shanghai Foreign Service Holding GroupLtd had liabilities of CN¥11.3b due within 12 months and liabilities of CN¥113.2m due beyond that. Offsetting this, it had CN¥11.1b in cash and CN¥2.93b in receivables that were due within 12 months. So it actually has CN¥2.68b more liquid assets than total liabilities.

This surplus suggests that Shanghai Foreign Service Holding GroupLtd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Shanghai Foreign Service Holding GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Shanghai Foreign Service Holding GroupLtd's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shanghai Foreign Service Holding GroupLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shanghai Foreign Service Holding GroupLtd 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. Happily for any shareholders, Shanghai Foreign Service Holding GroupLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Foreign Service Holding GroupLtd has net cash of CN¥10.1b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥957m, being 172% of its EBIT. So we don't think Shanghai Foreign Service Holding GroupLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shanghai Foreign Service Holding GroupLtd is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.