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.' 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 can see that Shenzhen JPT Opto-Electronics Co., Ltd. (SHSE:688025) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen JPT Opto-Electronics Carry?

As you can see below, at the end of March 2024, Shenzhen JPT Opto-Electronics had CN¥55.7m of debt, up from CN¥37.0m a year ago. Click the image for more detail. But it also has CN¥394.4m in cash to offset that, meaning it has CN¥338.7m net cash.

A Look At Shenzhen JPT Opto-Electronics' Liabilities

According to the last reported balance sheet, Shenzhen JPT Opto-Electronics had liabilities of CN¥504.2m due within 12 months, and liabilities of CN¥47.0m due beyond 12 months. On the other hand, it had cash of CN¥394.4m and CN¥515.2m worth of receivables due within a year. So it actually has CN¥358.4m more liquid assets than total liabilities.

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

On top of that, Shenzhen JPT Opto-Electronics grew its EBIT by 87% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shenzhen JPT Opto-Electronics can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shenzhen JPT Opto-Electronics 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, Shenzhen JPT Opto-Electronics 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 we empathize with investors who find debt concerning, you should keep in mind that Shenzhen JPT Opto-Electronics has net cash of CN¥338.7m, as well as more liquid assets than liabilities. And we liked the look of last year's 87% year-on-year EBIT growth. So we are not troubled with Shenzhen JPT Opto-Electronics's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Shenzhen JPT Opto-Electronics has 1 warning sign we think you should be aware of.

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.

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.

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