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 can see that Anhui Conch Cement Company Limited (HKG:914) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Anhui Conch Cement

How Much Debt Does Anhui Conch Cement Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Anhui Conch Cement had debt of CN¥30.7b, up from CN¥26.2b in one year. But it also has CN¥76.9b in cash to offset that, meaning it has CN¥46.2b net cash.

How Healthy Is Anhui Conch Cement's Balance Sheet?

The latest balance sheet data shows that Anhui Conch Cement had liabilities of CN¥28.6b due within a year, and liabilities of CN¥25.6b falling due after that. On the other hand, it had cash of CN¥76.9b and CN¥15.9b worth of receivables due within a year. So it actually has CN¥38.7b 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!

In fact Anhui Conch Cement's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Considering the last three years, Anhui Conch Cement actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Anhui Conch Cement has net cash of CN¥46.2b, as well as more liquid assets than liabilities. So we are not troubled with Anhui Conch Cement's debt use. 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. Case in point: We've spotted 1 warning sign for Anhui Conch Cement you should be aware of.

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.