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. We note that Leedarson IoT Technology Inc. (SHSE:605365) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Leedarson IoT Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Leedarson IoT Technology had CN¥259.7m of debt in March 2024, down from CN¥303.0m, one year before. But on the other hand it also has CN¥1.62b in cash, leading to a CN¥1.36b net cash position.

A Look At Leedarson IoT Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Leedarson IoT Technology had liabilities of CN¥1.93b due within 12 months and liabilities of CN¥328.9m due beyond that. Offsetting this, it had CN¥1.62b in cash and CN¥1.10b in receivables that were due within 12 months. So it actually has CN¥462.8m more liquid assets than total liabilities.

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

On the other hand, Leedarson IoT Technology's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Leedarson IoT Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Leedarson IoT 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, Leedarson IoT Technology recorded free cash flow worth 73% 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 it is always sensible to investigate a company's debt, in this case Leedarson IoT Technology has CN¥1.36b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in CN¥308m. So we don't have any problem with Leedarson IoT Technology's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Leedarson IoT Technology .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com