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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Jiangxi Lian Chuang Optoelectronic Science And Technology Co.,lTd. (SHSE:600363) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd Carry?

The image below, which you can click on for greater detail, shows that Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd had debt of CN¥1.38b at the end of March 2024, a reduction from CN¥1.48b over a year. However, it does have CN¥1.63b in cash offsetting this, leading to net cash of CN¥251.1m.

How Healthy Is Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd's Balance Sheet?

The latest balance sheet data shows that Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd had liabilities of CN¥2.57b due within a year, and liabilities of CN¥387.1m falling due after that. Offsetting these obligations, it had cash of CN¥1.63b as well as receivables valued at CN¥1.37b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥13.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd turned things around in the last 12 months, delivering and EBIT of CN¥70m. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jiangxi Lian Chuang Optoelectronic Science And 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. Over the last year, Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd actually produced more free cash flow than EBIT. 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 Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd has CN¥251.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥171m, being 243% of its EBIT. So we don't think Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Jiangxi Lian Chuang Optoelectronic Science And TechnologylTd, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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