Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Leader Harmonious Drive Systems Co., Ltd. (SHSE:688017) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. 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.

What Is Leader Harmonious Drive Systems's Net Debt?

As you can see below, at the end of March 2024, Leader Harmonious Drive Systems had CN¥614.5m of debt, up from CN¥308.7m a year ago. Click the image for more detail. But it also has CN¥1.22b in cash to offset that, meaning it has CN¥605.5m net cash.

A Look At Leader Harmonious Drive Systems' Liabilities

Zooming in on the latest balance sheet data, we can see that Leader Harmonious Drive Systems had liabilities of CN¥651.7m due within 12 months and liabilities of CN¥192.7m due beyond that. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥144.1m due within 12 months. So it can boast CN¥519.8m more liquid assets than total liabilities.

This surplus suggests that Leader Harmonious Drive Systems has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Leader Harmonious Drive Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Leader Harmonious Drive Systems's load is not too heavy, because its EBIT was down 55% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Leader Harmonious Drive Systems'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Leader Harmonious Drive Systems 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, Leader Harmonious Drive Systems 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 it is always sensible to investigate a company's debt, in this case Leader Harmonious Drive Systems has CN¥605.5m in net cash and a decent-looking balance sheet. So while Leader Harmonious Drive Systems does not have a great balance sheet, it's certainly not too bad. 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. For example - Leader Harmonious Drive Systems has 1 warning sign we think you should be aware of.

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.