Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that MeiG Smart Technology Co., Ltd (SZSE:002881) does have debt on its balance sheet. But is this debt a concern to shareholders?

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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is MeiG Smart Technology's Net Debt?

As you can see below, MeiG Smart Technology had CN¥378.5m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥507.9m in cash, so it actually has CN¥129.3m net cash.

How Strong Is MeiG Smart Technology's Balance Sheet?

The latest balance sheet data shows that MeiG Smart Technology had liabilities of CN¥1.10b due within a year, and liabilities of CN¥37.2m falling due after that. Offsetting this, it had CN¥507.9m in cash and CN¥664.3m in receivables that were due within 12 months. So it actually has CN¥38.0m more liquid assets than total liabilities.

Having regard to MeiG Smart Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥5.00b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, MeiG Smart Technology 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 MeiG Smart Technology if management cannot prevent a repeat of the 68% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine MeiG Smart Technology'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 MeiG Smart Technology 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 three years, MeiG Smart Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that MeiG Smart Technology has net cash of CN¥129.3m, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about MeiG Smart Technology's balance sheet. 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. Be aware that MeiG Smart Technology is showing 2 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.

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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