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.' 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. As with many other companies Jiangsu Changbao Steeltube Co.,Ltd (SZSE:002478) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Jiangsu Changbao SteeltubeLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Jiangsu Changbao SteeltubeLtd had CN¥150.0m of debt in September 2023, down from CN¥281.1m, one year before. But it also has CN¥2.18b in cash to offset that, meaning it has CN¥2.03b net cash.

How Healthy Is Jiangsu Changbao SteeltubeLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Jiangsu Changbao SteeltubeLtd had liabilities of CN¥2.54b due within 12 months and liabilities of CN¥51.8m due beyond that. On the other hand, it had cash of CN¥2.18b and CN¥1.65b worth of receivables due within a year. So it can boast CN¥1.24b more liquid assets than total liabilities.

This excess liquidity suggests that Jiangsu Changbao SteeltubeLtd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Jiangsu Changbao SteeltubeLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that Jiangsu Changbao SteeltubeLtd grew its EBIT by 146% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Jiangsu Changbao SteeltubeLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Jiangsu Changbao SteeltubeLtd 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. Looking at the most recent three years, Jiangsu Changbao SteeltubeLtd recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangsu Changbao SteeltubeLtd has CN¥2.03b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 146% over the last year. So we don't think Jiangsu Changbao SteeltubeLtd'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. For example, we've discovered 1 warning sign for Jiangsu Changbao SteeltubeLtd that you should be aware of before investing here.

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.