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. As with many other companies China Resources Beer (Holdings) Company Limited (HKG:291) makes use of debt. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for China Resources Beer (Holdings)

How Much Debt Does China Resources Beer (Holdings) Carry?

The image below, which you can click on for greater detail, shows that at June 2019 China Resources Beer (Holdings) had debt of CN¥1.31b, up from CN¥3.1k in one year. But on the other hand it also has CN¥4.06b in cash, leading to a CN¥2.75b net cash position.

How Healthy Is China Resources Beer (Holdings)'s Balance Sheet?

The latest balance sheet data shows that China Resources Beer (Holdings) had liabilities of CN¥22.3b due within a year, and liabilities of CN¥2.45b falling due after that. Offsetting these obligations, it had cash of CN¥4.06b as well as receivables valued at CN¥2.59b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥18.1b.

Of course, China Resources Beer (Holdings) has a titanic market capitalization of CN¥123.2b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, China Resources Beer (Holdings) also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that China Resources Beer (Holdings) grew its EBIT by 19% last year, making its debt load easier to handle. 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 China Resources Beer (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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Resources Beer (Holdings) 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. Happily for any shareholders, China Resources Beer (Holdings) actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although China Resources Beer (Holdings)'s balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.75b. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in CN¥3.0b. So is China Resources Beer (Holdings)'s debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in China Resources Beer (Holdings), you may well want to click here to check an interactive graph of its earnings per share history.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.