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 Jiangsu Hengli Hydraulic Co.,Ltd (SHSE:601100) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Jiangsu Hengli HydraulicLtd's Debt?

The image below, which you can click on for greater detail, shows that Jiangsu Hengli HydraulicLtd had debt of CN¥199.6m at the end of March 2024, a reduction from CN¥305.1m over a year. However, it does have CN¥7.81b in cash offsetting this, leading to net cash of CN¥7.61b.

How Healthy Is Jiangsu Hengli HydraulicLtd's Balance Sheet?

According to the last reported balance sheet, Jiangsu Hengli HydraulicLtd had liabilities of CN¥3.17b due within 12 months, and liabilities of CN¥346.8m due beyond 12 months. Offsetting this, it had CN¥7.81b in cash and CN¥3.29b in receivables that were due within 12 months. So it can boast CN¥7.59b more liquid assets than total liabilities.

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

Fortunately, Jiangsu Hengli HydraulicLtd grew its EBIT by 4.0% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Hengli HydraulicLtd can strengthen its balance sheet over time. 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 Hengli HydraulicLtd 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 most recent three years, Jiangsu Hengli HydraulicLtd recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu Hengli HydraulicLtd has net cash of CN¥7.61b, as well as more liquid assets than liabilities. So is Jiangsu Hengli HydraulicLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Jiangsu Hengli HydraulicLtd (1 can't be ignored) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.