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.' 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. Importantly, MGI Tech Co., Ltd. (SHSE:688114) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is MGI Tech's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 MGI Tech had debt of CN¥487.1m, up from CN¥299.6m in one year. But on the other hand it also has CN¥3.62b in cash, leading to a CN¥3.14b net cash position.

A Look At MGI Tech's Liabilities

According to the last reported balance sheet, MGI Tech had liabilities of CN¥1.28b due within 12 months, and liabilities of CN¥672.3m due beyond 12 months. Offsetting this, it had CN¥3.62b in cash and CN¥1.23b in receivables that were due within 12 months. So it can boast CN¥2.90b more liquid assets than total liabilities.

This short term liquidity is a sign that MGI Tech could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, MGI Tech boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if MGI Tech 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.

In the last year MGI Tech had a loss before interest and tax, and actually shrunk its revenue by 18%, to CN¥2.6b. We would much prefer see growth.

So How Risky Is MGI Tech?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that MGI Tech had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥1.4b and booked a CN¥873m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of CN¥3.14b. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for MGI Tech you should know about.

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.

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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.