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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Chongqing Brewery Co., Ltd. (SHSE:600132) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Chongqing Brewery's Net Debt?

As you can see below, at the end of September 2023, Chongqing Brewery had CN¥95.4m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥5.26b in cash, so it actually has CN¥5.17b net cash.

How Strong Is Chongqing Brewery's Balance Sheet?

We can see from the most recent balance sheet that Chongqing Brewery had liabilities of CN¥8.47b falling due within a year, and liabilities of CN¥546.7m due beyond that. Offsetting this, it had CN¥5.26b in cash and CN¥380.2m in receivables that were due within 12 months. So its liabilities total CN¥3.37b more than the combination of its cash and short-term receivables.

Given Chongqing Brewery has a market capitalization of CN¥31.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Chongqing Brewery also has more cash than debt, so we're pretty confident it can manage its debt safely.

The good news is that Chongqing Brewery has increased its EBIT by 7.6% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chongqing Brewery'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Chongqing Brewery 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, Chongqing Brewery generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although Chongqing Brewery's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥5.17b. And it impressed us with free cash flow of CN¥2.3b, being 86% of its EBIT. So we don't think Chongqing Brewery's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Chongqing Brewery .

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.