Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, L.K. Technology Holdings Limited (HKG:558) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does L.K. Technology Holdings Carry?

The image below, which you can click on for greater detail, shows that at March 2024 L.K. Technology Holdings had debt of HK$1.79b, up from HK$1.64b in one year. However, it does have HK$2.38b in cash offsetting this, leading to net cash of HK$582.3m.

How Healthy Is L.K. Technology Holdings' Balance Sheet?

The latest balance sheet data shows that L.K. Technology Holdings had liabilities of HK$4.16b due within a year, and liabilities of HK$2.73b falling due after that. On the other hand, it had cash of HK$2.38b and HK$3.07b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.44b.

L.K. Technology Holdings has a market capitalization of HK$3.67b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, L.K. Technology Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, L.K. Technology Holdings saw its EBIT drop by 2.5% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 L.K. Technology Holdings'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 company can only pay off debt with cold hard cash, not accounting profits. L.K. Technology Holdings 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, L.K. Technology Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While L.K. Technology Holdings does have more liabilities than liquid assets, it also has net cash of HK$582.3m. So while L.K. Technology Holdings does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. 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 2 warning signs for L.K. Technology Holdings (of which 1 makes us a bit uncomfortable!) 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.