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. We can see that Shenzhen Lifotronic Technology Co., Ltd. (SHSE:688389) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen Lifotronic Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shenzhen Lifotronic Technology had CN¥235.0m of debt, an increase on CN¥180.0m, over one year. However, its balance sheet shows it holds CN¥1.11b in cash, so it actually has CN¥875.8m net cash.

How Healthy Is Shenzhen Lifotronic Technology's Balance Sheet?

According to the last reported balance sheet, Shenzhen Lifotronic Technology had liabilities of CN¥466.7m due within 12 months, and liabilities of CN¥9.33m due beyond 12 months. On the other hand, it had cash of CN¥1.11b and CN¥134.0m worth of receivables due within a year. So it actually has CN¥768.9m more liquid assets than total liabilities.

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

On top of that, Shenzhen Lifotronic Technology grew its EBIT by 64% 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 ultimately the future profitability of the business will decide if Shenzhen Lifotronic Technology can strengthen its balance sheet over time. 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 Shenzhen Lifotronic Technology 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 most recent three years, Shenzhen Lifotronic Technology recorded free cash flow worth 53% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shenzhen Lifotronic Technology has net cash of CN¥875.8m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 64% over the last year. So is Shenzhen Lifotronic Technology's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shenzhen Lifotronic Technology that you should be aware of.

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.