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 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, MLOptic Corp. (SHSE:688502) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does MLOptic Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 MLOptic had CN¥67.0m of debt, an increase on CN¥62.0m, over one year. But it also has CN¥508.5m in cash to offset that, meaning it has CN¥441.5m net cash.

A Look At MLOptic's Liabilities

The latest balance sheet data shows that MLOptic had liabilities of CN¥168.2m due within a year, and liabilities of CN¥15.6m falling due after that. Offsetting this, it had CN¥508.5m in cash and CN¥114.8m in receivables that were due within 12 months. So it actually has CN¥439.5m more liquid assets than total liabilities.

This surplus suggests that MLOptic has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, MLOptic 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 MLOptic if management cannot prevent a repeat of the 58% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 MLOptic'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 MLOptic 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. During the last three years, MLOptic burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that MLOptic has net cash of CN¥441.5m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about MLOptic'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. To that end, you should learn about the 3 warning signs we've spotted with MLOptic (including 1 which makes us a bit uncomfortable) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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