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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Shanghai Foreign Service Holding Group Co., Ltd. (SHSE:600662) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shanghai Foreign Service Holding Group

What Is Shanghai Foreign Service Holding Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shanghai Foreign Service Holding Group had CN¥1.00b of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥9.37b in cash, so it actually has CN¥8.37b net cash.

A Look At Shanghai Foreign Service Holding Group's Liabilities

The latest balance sheet data shows that Shanghai Foreign Service Holding Group had liabilities of CN¥10.3b due within a year, and liabilities of CN¥112.7m falling due after that. Offsetting this, it had CN¥9.37b in cash and CN¥2.33b in receivables that were due within 12 months. So it actually has CN¥1.27b more liquid assets than total liabilities.

This surplus suggests that Shanghai Foreign Service Holding Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shanghai Foreign Service Holding Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Shanghai Foreign Service Holding Group grew its EBIT by 8.1% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Foreign Service Holding Group can strengthen its balance sheet over time. 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 Group 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. During the last three years, Shanghai Foreign Service Holding Group generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shanghai Foreign Service Holding Group has CN¥8.37b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 80% of that EBIT to free cash flow, bringing in -CN¥1.4b. So we don't think Shanghai Foreign Service Holding Group's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Shanghai Foreign Service Holding Group .

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.