Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Leyard Optoelectronic Co., Ltd. (SZSE:300296) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Leyard Optoelectronic's Net Debt?

As you can see below, Leyard Optoelectronic had CN¥1.23b of debt at June 2024, down from CN¥1.64b a year prior. But on the other hand it also has CN¥2.14b in cash, leading to a CN¥912.5m net cash position.

How Healthy Is Leyard Optoelectronic's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Leyard Optoelectronic had liabilities of CN¥4.50b due within 12 months and liabilities of CN¥1.33b due beyond that. Offsetting this, it had CN¥2.14b in cash and CN¥5.11b in receivables that were due within 12 months. So it actually has CN¥1.43b more liquid assets than total liabilities.

This short term liquidity is a sign that Leyard Optoelectronic could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Leyard Optoelectronic boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Leyard Optoelectronic's saving grace is its low debt levels, because its EBIT has tanked 81% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Leyard Optoelectronic's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Leyard Optoelectronic 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 most recent three years, Leyard Optoelectronic recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Leyard Optoelectronic has net cash of CN¥912.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥670m, being 78% of its EBIT. So we don't have any problem with Leyard Optoelectronic's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Leyard Optoelectronic you should know about.

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.

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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.