Here's Why Shede Spirits (SHSE:600702) Can Manage Its Debt Responsibly

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.' 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 note that Shede Spirits Co., Ltd. (SHSE:600702) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shede Spirits

What Is Shede Spirits's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shede Spirits had CN¥445.6m of debt, an increase on CN¥80.1m, over one year. However, its balance sheet shows it holds CN¥3.08b in cash, so it actually has CN¥2.63b net cash.

How Strong Is Shede Spirits' Balance Sheet?

We can see from the most recent balance sheet that Shede Spirits had liabilities of CN¥3.75b falling due within a year, and liabilities of CN¥171.7m due beyond that. Offsetting this, it had CN¥3.08b in cash and CN¥916.8m in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Shede Spirits' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥24.4b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Shede Spirits boasts net cash, so it's fair to say it does not have a heavy debt load!

Shede Spirits's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shede Spirits'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shede Spirits 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. In the last three years, Shede Spirits's free cash flow amounted to 29% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shede Spirits has net cash of CN¥2.63b, as well as more liquid assets than liabilities. So we don't have any problem with Shede Spirits's use of debt. 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 2 warning signs for Shede Spirits you should be aware of, and 1 of them is a bit concerning.

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.