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. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Public Joint Stock Company Aeroflot - Russian Airlines (MCX:AFLT) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Aeroflot - Russian Airlines

How Much Debt Does Aeroflot - Russian Airlines Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2019 Aeroflot - Russian Airlines had ₽15.8b of debt, an increase on ₽3.49b, over one year. However, its balance sheet shows it holds ₽29.7b in cash, so it actually has ₽13.9b net cash.

How Strong Is Aeroflot - Russian Airlines's Balance Sheet?

According to the last reported balance sheet, Aeroflot - Russian Airlines had liabilities of ₽237.4b due within 12 months, and liabilities of ₽694.0b due beyond 12 months. Offsetting these obligations, it had cash of ₽29.7b as well as receivables valued at ₽55.8b due within 12 months. So it has liabilities totalling ₽845.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₽75.0b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Aeroflot - Russian Airlines would probably need a major re-capitalization if its creditors were to demand repayment. Aeroflot - Russian Airlines boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Unfortunately, Aeroflot - Russian Airlines saw its EBIT slide 3.6% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Aeroflot - Russian Airlines can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Aeroflot - Russian Airlines 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. Happily for any shareholders, Aeroflot - Russian Airlines actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Aeroflot - Russian Airlines does have more liabilities than liquid assets, it also has net cash of ₽13.9b. The cherry on top was that in converted 135% of that EBIT to free cash flow, bringing in ₽97b. Despite the cash, we do find Aeroflot - Russian Airlines's level of total liabilities concerning, so we're not particularly comfortable with the stock. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Aeroflot - Russian Airlines you should be aware of, and 1 of them doesn't sit too well with us.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.