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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shanghai Wanye Enterprises Co.,Ltd (SHSE:600641) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shanghai Wanye EnterprisesLtd

What Is Shanghai Wanye EnterprisesLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shanghai Wanye EnterprisesLtd had CN¥567.6m of debt, an increase on CN¥154.5m, over one year. However, it does have CN¥3.74b in cash offsetting this, leading to net cash of CN¥3.17b.

How Healthy Is Shanghai Wanye EnterprisesLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai Wanye EnterprisesLtd had liabilities of CN¥765.4m due within 12 months and liabilities of CN¥815.9m due beyond that. Offsetting this, it had CN¥3.74b in cash and CN¥105.2m in receivables that were due within 12 months. So it actually has CN¥2.26b more liquid assets than total liabilities.

It's good to see that Shanghai Wanye EnterprisesLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Shanghai Wanye EnterprisesLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Shanghai Wanye EnterprisesLtd turned things around in the last 12 months, delivering and EBIT of CN¥340m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shanghai Wanye EnterprisesLtd'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 Wanye EnterprisesLtd 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. Over the last year, Shanghai Wanye EnterprisesLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shanghai Wanye EnterprisesLtd has net cash of CN¥3.17b, as well as more liquid assets than liabilities. So we don't have any problem with Shanghai Wanye EnterprisesLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shanghai Wanye EnterprisesLtd has 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.