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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, TCL Electronics Holdings Limited (HKG:1070) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is TCL Electronics Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 TCL Electronics Holdings had HK$6.65b of debt, an increase on HK$5.44b, over one year. But it also has HK$10.4b in cash to offset that, meaning it has HK$3.74b net cash.

How Healthy Is TCL Electronics Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that TCL Electronics Holdings had liabilities of HK$52.6b due within 12 months and liabilities of HK$1.51b due beyond that. On the other hand, it had cash of HK$10.4b and HK$20.1b worth of receivables due within a year. So its liabilities total HK$23.6b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$13.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, TCL Electronics Holdings would likely require a major re-capitalisation if it had to pay its creditors today. Given that TCL Electronics Holdings has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

We also note that TCL Electronics Holdings improved its EBIT from a last year's loss to a positive HK$691m. 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 TCL Electronics Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. TCL Electronics Holdings 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. Happily for any shareholders, TCL Electronics Holdings actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

Although TCL Electronics Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of HK$3.74b. And it impressed us with free cash flow of HK$1.4b, being 203% of its EBIT. So while TCL Electronics Holdings does not have a great balance sheet, it's certainly not too bad. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of TCL Electronics Holdings's earnings per share history for free.

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.