Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 AVIC Jonhon Optronic Technology Co.,Ltd. (SZSE:002179) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

What Is AVIC Jonhon Optronic TechnologyLtd's Net Debt?

As you can see below, AVIC Jonhon Optronic TechnologyLtd had CN¥870.1m of debt at March 2024, down from CN¥1.45b a year prior. However, its balance sheet shows it holds CN¥9.03b in cash, so it actually has CN¥8.16b net cash.

How Strong Is AVIC Jonhon Optronic TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that AVIC Jonhon Optronic TechnologyLtd had liabilities of CN¥11.5b due within 12 months and liabilities of CN¥991.4m due beyond that. Offsetting this, it had CN¥9.03b in cash and CN¥13.6b in receivables that were due within 12 months. So it actually has CN¥10.2b more liquid assets than total liabilities.

This surplus suggests that AVIC Jonhon Optronic TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, AVIC Jonhon Optronic TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that AVIC Jonhon Optronic TechnologyLtd has increased its EBIT by 5.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine AVIC Jonhon Optronic TechnologyLtd'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, a company can only pay off debt with cold hard cash, not accounting profits. While AVIC Jonhon Optronic TechnologyLtd 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, AVIC Jonhon Optronic TechnologyLtd recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case AVIC Jonhon Optronic TechnologyLtd has CN¥8.16b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 5.8% in the last twelve months. So we are not troubled with AVIC Jonhon Optronic TechnologyLtd's debt use. 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. We've identified 1 warning sign with AVIC Jonhon Optronic TechnologyLtd , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com