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 Chengdu RML Technology Co., Ltd. (SZSE:301050) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Chengdu RML Technology Carry?

As you can see below, Chengdu RML Technology had CN¥30.0m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥1.70b in cash to offset that, meaning it has CN¥1.67b net cash.

A Look At Chengdu RML Technology's Liabilities

According to the last reported balance sheet, Chengdu RML Technology had liabilities of CN¥724.5m due within 12 months, and liabilities of CN¥32.1m due beyond 12 months. On the other hand, it had cash of CN¥1.70b and CN¥327.3m worth of receivables due within a year. So it can boast CN¥1.27b more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Chengdu RML Technology has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Chengdu RML Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Chengdu RML Technology 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. Looking at the most recent three years, Chengdu RML Technology recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chengdu RML Technology has CN¥1.67b in net cash and a decent-looking balance sheet. And we liked the look of last year's 42% year-on-year EBIT growth. So is Chengdu RML Technology's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. 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 1 warning sign for Chengdu RML Technology you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.