Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Keli Sensing Technology (Ningbo) Co.,Ltd. (SHSE:603662) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Keli Sensing Technology (Ningbo)Ltd Carry?

The image below, which you can click on for greater detail, shows that Keli Sensing Technology (Ningbo)Ltd had debt of CN¥676.6m at the end of June 2024, a reduction from CN¥721.9m over a year. However, it does have CN¥1.36b in cash offsetting this, leading to net cash of CN¥685.1m.

How Strong Is Keli Sensing Technology (Ningbo)Ltd's Balance Sheet?

The latest balance sheet data shows that Keli Sensing Technology (Ningbo)Ltd had liabilities of CN¥1.25b due within a year, and liabilities of CN¥42.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.36b as well as receivables valued at CN¥596.8m due within 12 months. So it can boast CN¥671.0m more liquid assets than total liabilities.

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

And we also note warmly that Keli Sensing Technology (Ningbo)Ltd grew its EBIT by 18% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Keli Sensing Technology (Ningbo)Ltd 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Keli Sensing Technology (Ningbo)Ltd 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 last three years, Keli Sensing Technology (Ningbo)Ltd reported free cash flow worth 6.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Keli Sensing Technology (Ningbo)Ltd has net cash of CN¥685.1m, as well as more liquid assets than liabilities. And we liked the look of last year's 18% year-on-year EBIT growth. So we don't have any problem with Keli Sensing Technology (Ningbo)Ltd's use of debt. 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 example, we've discovered 3 warning signs for Keli Sensing Technology (Ningbo)Ltd that you should be aware of before investing here.

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.