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 Zhongji Innolight Co., Ltd. (SZSE:300308) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Zhongji Innolight Carry?

The chart below, which you can click on for greater detail, shows that Zhongji Innolight had CN¥1.32b in debt in June 2024; about the same as the year before. However, it does have CN¥3.59b in cash offsetting this, leading to net cash of CN¥2.26b.

A Look At Zhongji Innolight's Liabilities

Zooming in on the latest balance sheet data, we can see that Zhongji Innolight had liabilities of CN¥5.39b due within 12 months and liabilities of CN¥1.89b due beyond that. Offsetting these obligations, it had cash of CN¥3.59b as well as receivables valued at CN¥4.36b due within 12 months. So it can boast CN¥665.1m more liquid assets than total liabilities.

This state of affairs indicates that Zhongji Innolight's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥117.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Zhongji Innolight boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Zhongji Innolight grew its EBIT by 195% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Zhongji Innolight 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 Zhongji Innolight 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. Looking at the most recent three years, Zhongji Innolight recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhongji Innolight has CN¥2.26b in net cash and a decent-looking balance sheet. And we liked the look of last year's 195% year-on-year EBIT growth. So we don't think Zhongji Innolight's use of debt is risky. 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. Be aware that Zhongji Innolight is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.