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, Shanghai M&G Stationery Inc. (SHSE:603899) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Shanghai M&G Stationery

What Is Shanghai M&G Stationery's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shanghai M&G Stationery had debt of CN¥418.9m, up from CN¥357.9m in one year. However, its balance sheet shows it holds CN¥5.49b in cash, so it actually has CN¥5.08b net cash.

How Strong Is Shanghai M&G Stationery's Balance Sheet?

The latest balance sheet data shows that Shanghai M&G Stationery had liabilities of CN¥5.63b due within a year, and liabilities of CN¥379.5m falling due after that. Offsetting this, it had CN¥5.49b in cash and CN¥4.04b in receivables that were due within 12 months. So it can boast CN¥3.52b more liquid assets than total liabilities.

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

Shanghai M&G Stationery's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of 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 Shanghai M&G Stationery'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, a company can only pay off debt with cold hard cash, not accounting profits. While Shanghai M&G Stationery 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. Over the most recent three years, Shanghai M&G Stationery recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai M&G Stationery has net cash of CN¥5.08b, as well as more liquid assets than liabilities. The cherry on top was that in converted 79% of that EBIT to free cash flow, bringing in CN¥1.6b. So we don't think Shanghai M&G Stationery's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Shanghai M&G Stationery , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.