Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Anjoy Foods Group Co., Ltd. (SHSE:603345) does carry debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Anjoy Foods Group's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Anjoy Foods Group had debt of CN¥500.2m, up from CN¥439.7m in one year. However, it does have CN¥6.12b in cash offsetting this, leading to net cash of CN¥5.62b.

How Healthy Is Anjoy Foods Group's Balance Sheet?

According to the last reported balance sheet, Anjoy Foods Group had liabilities of CN¥3.78b due within 12 months, and liabilities of CN¥400.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥6.12b as well as receivables valued at CN¥570.9m due within 12 months. So it actually has CN¥2.51b more liquid assets than total liabilities.

This surplus suggests that Anjoy Foods Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Anjoy Foods Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Anjoy Foods Group grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anjoy Foods Group'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. While Anjoy Foods Group 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, Anjoy Foods Group reported free cash flow worth 4.1% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Anjoy Foods Group has CN¥5.62b in net cash and a decent-looking balance sheet. And we liked the look of last year's 77% year-on-year EBIT growth. So we don't think Anjoy Foods Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Anjoy Foods Group has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.