Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 LONGi Green Energy Technology Co., Ltd. (SHSE:601012) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is LONGi Green Energy Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 LONGi Green Energy Technology had debt of CN¥19.5b, up from CN¥9.88b in one year. However, its balance sheet shows it holds CN¥57.3b in cash, so it actually has CN¥37.8b net cash.

How Healthy Is LONGi Green Energy Technology's Balance Sheet?

According to the last reported balance sheet, LONGi Green Energy Technology had liabilities of CN¥71.5b due within 12 months, and liabilities of CN¥28.5b due beyond 12 months. Offsetting this, it had CN¥57.3b in cash and CN¥13.9b in receivables that were due within 12 months. So it has liabilities totalling CN¥28.7b more than its cash and near-term receivables, combined.

This deficit isn't so bad because LONGi Green Energy Technology is worth a massive CN¥124.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, LONGi Green Energy Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for LONGi Green Energy Technology if management cannot prevent a repeat of the 51% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine LONGi Green Energy Technology's ability to maintain a healthy balance sheet going forward. 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. LONGi Green Energy Technology 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. During the last three years, LONGi Green Energy Technology generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While LONGi Green Energy Technology does have more liabilities than liquid assets, it also has net cash of CN¥37.8b. And it impressed us with free cash flow of -CN¥1.5b, being 85% of its EBIT. So we don't have any problem with LONGi Green Energy Technology'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. Be aware that LONGi Green Energy Technology is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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