Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Inner Mongolia OJing Science & Technology Co., Ltd. (SZSE:001269) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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.

What Is Inner Mongolia OJing Science & Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Inner Mongolia OJing Science & Technology had debt of CN¥210.9m, up from CN¥95.9m in one year. But on the other hand it also has CN¥363.0m in cash, leading to a CN¥152.0m net cash position.

How Strong Is Inner Mongolia OJing Science & Technology's Balance Sheet?

We can see from the most recent balance sheet that Inner Mongolia OJing Science & Technology had liabilities of CN¥1.10b falling due within a year, and liabilities of CN¥158.6m due beyond that. Offsetting this, it had CN¥363.0m in cash and CN¥1.27b in receivables that were due within 12 months. So it can boast CN¥373.3m more liquid assets than total liabilities.

This surplus suggests that Inner Mongolia OJing Science & Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Inner Mongolia OJing Science & Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Inner Mongolia OJing Science & Technology grew its EBIT by 292% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Inner Mongolia OJing Science & Technology 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Inner Mongolia OJing Science & Technology 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 last three years, Inner Mongolia OJing Science & Technology 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 Inner Mongolia OJing Science & Technology has net cash of CN¥152.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 292% year-on-year EBIT growth. So we don't have any problem with Inner Mongolia OJing Science & Technology's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Inner Mongolia OJing Science & Technology (at least 2 which are significant) , 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.