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. We note that Cosonic Intelligent Technologies Co., Ltd. (SZSE:300793) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Cosonic Intelligent Technologies's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Cosonic Intelligent Technologies had debt of CN¥1.13b, up from CN¥398.4m in one year. But it also has CN¥1.91b in cash to offset that, meaning it has CN¥786.9m net cash.

How Healthy Is Cosonic Intelligent Technologies' Balance Sheet?

The latest balance sheet data shows that Cosonic Intelligent Technologies had liabilities of CN¥782.8m due within a year, and liabilities of CN¥966.9m falling due after that. Offsetting these obligations, it had cash of CN¥1.91b as well as receivables valued at CN¥451.7m due within 12 months. So it actually has CN¥615.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Cosonic Intelligent Technologies could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Cosonic Intelligent Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Cosonic Intelligent Technologies's saving grace is its low debt levels, because its EBIT has tanked 54% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Cosonic Intelligent Technologies will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Cosonic Intelligent Technologies 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. Over the last three years, Cosonic Intelligent Technologies saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Cosonic Intelligent Technologies has CN¥786.9m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Cosonic Intelligent Technologies's balance sheet. 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 Cosonic Intelligent Technologies is showing 4 warning signs in our investment analysis , you should know about...

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.

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