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 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. As with many other companies Kingclean Electric Co.,Ltd (SHSE:603355) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Kingclean ElectricLtd's Net Debt?

As you can see below, at the end of September 2024, Kingclean ElectricLtd had CN¥5.11b of debt, up from CN¥3.52b a year ago. Click the image for more detail. However, it does have CN¥5.94b in cash offsetting this, leading to net cash of CN¥822.5m.

How Healthy Is Kingclean ElectricLtd's Balance Sheet?

The latest balance sheet data shows that Kingclean ElectricLtd had liabilities of CN¥5.90b due within a year, and liabilities of CN¥1.97b falling due after that. Offsetting this, it had CN¥5.94b in cash and CN¥2.34b in receivables that were due within 12 months. So it can boast CN¥408.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Kingclean ElectricLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Kingclean ElectricLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Kingclean ElectricLtd grew its EBIT by 7.4% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kingclean ElectricLtd'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 Kingclean ElectricLtd 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. During the last three years, Kingclean ElectricLtd produced sturdy free cash flow equating to 65% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Kingclean ElectricLtd has net cash of CN¥822.5m, as well as more liquid assets than liabilities. So we don't think Kingclean ElectricLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for Kingclean ElectricLtd that you should be aware of before investing here.

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.