David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Loncin Motor Co., Ltd. (SHSE:603766) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Loncin Motor's Net Debt?

As you can see below, Loncin Motor had CN¥301.3m of debt at September 2024, down from CN¥674.7m a year prior. However, its balance sheet shows it holds CN¥5.81b in cash, so it actually has CN¥5.50b net cash.

How Healthy Is Loncin Motor's Balance Sheet?

The latest balance sheet data shows that Loncin Motor had liabilities of CN¥5.64b due within a year, and liabilities of CN¥285.3m falling due after that. Offsetting these obligations, it had cash of CN¥5.81b as well as receivables valued at CN¥2.38b due within 12 months. So it can boast CN¥2.26b more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Loncin Motor has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 Loncin Motor can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Loncin Motor 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. Happily for any shareholders, Loncin Motor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Loncin Motor has CN¥5.50b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥842m, being 126% of its EBIT. So is Loncin Motor's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Loncin Motor .

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.

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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.