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.' 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 PDD Holdings Inc. (NASDAQ:PDD) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for PDD Holdings

What Is PDD Holdings's Net Debt?

As you can see below, PDD Holdings had CN¥5.18b of debt at September 2024, down from CN¥16.0b a year prior. However, it does have CN¥308.5b in cash offsetting this, leading to net cash of CN¥303.3b.

How Healthy Is PDD Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PDD Holdings had liabilities of CN¥180.0b due within 12 months and liabilities of CN¥8.29b due beyond that. Offsetting this, it had CN¥308.5b in cash and CN¥13.9b in receivables that were due within 12 months. So it actually has CN¥134.1b more liquid assets than total liabilities.

This surplus suggests that PDD Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, PDD Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, PDD Holdings grew its EBIT by 132% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PDD Holdings can strengthen its balance sheet over time. 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. PDD Holdings 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. Over the last three years, PDD Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that PDD Holdings has net cash of CN¥303.3b, as well as more liquid assets than liabilities. The cherry on top was that in converted 138% of that EBIT to free cash flow, bringing in CN¥129b. So is PDD Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for PDD Holdings you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.