David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Lao Feng Xiang Co., Ltd. (SHSE:600612) does use debt in its business. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Lao Feng Xiang

What Is Lao Feng Xiang's Net Debt?

The chart below, which you can click on for greater detail, shows that Lao Feng Xiang had CN¥8.32b in debt in September 2023; about the same as the year before. However, it does have CN¥11.1b in cash offsetting this, leading to net cash of CN¥2.79b.

How Healthy Is Lao Feng Xiang's Balance Sheet?

According to the last reported balance sheet, Lao Feng Xiang had liabilities of CN¥12.6b due within 12 months, and liabilities of CN¥311.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥11.1b as well as receivables valued at CN¥6.64b due within 12 months. So it can boast CN¥4.85b more liquid assets than total liabilities.

This surplus suggests that Lao Feng Xiang is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Lao Feng Xiang has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that Lao Feng Xiang has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. 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 Lao Feng Xiang'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. Lao Feng Xiang 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, Lao Feng Xiang actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Lao Feng Xiang has net cash of CN¥2.79b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥4.8b, being 103% of its EBIT. When it comes to Lao Feng Xiang's debt, we sufficiently relaxed that our mind turns to the jacuzzi. Over time, share prices tend to follow earnings per share, so if you're interested in Lao Feng Xiang, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.