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. As with many other companies POCO Holding Co., Ltd. (SZSE:300811) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is POCO Holding's Debt?

The image below, which you can click on for greater detail, shows that POCO Holding had debt of CN¥140.2m at the end of September 2024, a reduction from CN¥155.7m over a year. But it also has CN¥302.0m in cash to offset that, meaning it has CN¥161.8m net cash.

How Strong Is POCO Holding's Balance Sheet?

We can see from the most recent balance sheet that POCO Holding had liabilities of CN¥307.8m falling due within a year, and liabilities of CN¥316.7m due beyond that. Offsetting this, it had CN¥302.0m in cash and CN¥830.7m in receivables that were due within 12 months. So it can boast CN¥508.2m more liquid assets than total liabilities.

This short term liquidity is a sign that POCO Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that POCO Holding has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, POCO Holding grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine POCO Holding'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 company can only pay off debt with cold hard cash, not accounting profits. While POCO Holding 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. Over the last three years, POCO Holding saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that POCO Holding has net cash of CN¥161.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 39% over the last year. So we are not troubled with POCO Holding's debt use. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of POCO Holding's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.