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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Launch Tech Company Limited (HKG:2488) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Launch Tech's Debt?

The chart below, which you can click on for greater detail, shows that Launch Tech had CN¥351.6m in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥548.8m in cash, leading to a CN¥197.2m net cash position.

A Look At Launch Tech's Liabilities

According to the last reported balance sheet, Launch Tech had liabilities of CN¥775.2m due within 12 months, and liabilities of CN¥13.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥548.8m as well as receivables valued at CN¥306.8m due within 12 months. So it actually has CN¥67.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Launch Tech could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Launch Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Launch Tech grew its EBIT by 192% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Launch Tech will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Launch Tech 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. Looking at the most recent three years, Launch Tech recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Launch Tech has net cash of CN¥197.2m, as well as more liquid assets than liabilities. And we liked the look of last year's 192% year-on-year EBIT growth. So we don't think Launch Tech's use of debt is risky. 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, we've discovered 2 warning signs for Launch Tech that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.