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 Anhui Conch Cement Company Limited (HKG:914) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Anhui Conch Cement Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Anhui Conch Cement had CN¥26.2b of debt, an increase on CN¥20.2b, over one year. However, its balance sheet shows it holds CN¥69.5b in cash, so it actually has CN¥43.3b net cash.

How Healthy Is Anhui Conch Cement's Balance Sheet?

According to the last reported balance sheet, Anhui Conch Cement had liabilities of CN¥31.1b due within 12 months, and liabilities of CN¥19.4b due beyond 12 months. Offsetting this, it had CN¥69.5b in cash and CN¥20.6b in receivables that were due within 12 months. So it can boast CN¥39.6b more liquid assets than total liabilities.

This surplus liquidity suggests that Anhui Conch Cement's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Anhui Conch Cement boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Anhui Conch Cement's load is not too heavy, because its EBIT was down 54% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Anhui Conch Cement'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Anhui Conch Cement 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. In the last three years, Anhui Conch Cement created free cash flow amounting to 11% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Anhui Conch Cement has CN¥43.3b in net cash and a decent-looking balance sheet. So we don't have any problem with Anhui Conch Cement'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. Be aware that Anhui Conch Cement is showing 2 warning signs in our investment analysis , you should know about...

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.