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. Importantly, KSEC Intelligent Technology Co., Ltd. (SZSE:301311) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is KSEC Intelligent Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 KSEC Intelligent Technology had CN¥450.3m of debt, an increase on CN¥300.2m, over one year. But on the other hand it also has CN¥650.6m in cash, leading to a CN¥200.2m net cash position.

How Strong Is KSEC Intelligent Technology's Balance Sheet?

We can see from the most recent balance sheet that KSEC Intelligent Technology had liabilities of CN¥2.22b falling due within a year, and liabilities of CN¥524.2m due beyond that. On the other hand, it had cash of CN¥650.6m and CN¥1.63b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥466.9m.

Given KSEC Intelligent Technology has a market capitalization of CN¥5.40b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, KSEC Intelligent Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, KSEC Intelligent Technology's EBIT dived 15%, 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 you can't view debt in total isolation; since KSEC Intelligent Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While KSEC Intelligent 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 last three years, KSEC Intelligent Technology 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 look at a company's total liabilities, it is very reassuring that KSEC Intelligent Technology has CN¥200.2m in net cash. So although we see some areas for improvement, we're not too worried about KSEC Intelligent Technology's balance sheet. 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. To that end, you should learn about the 3 warning signs we've spotted with KSEC Intelligent Technology (including 2 which are a bit concerning) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.