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 can see that Newland Digital Technology Co.,Ltd. (SZSE:000997) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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 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. 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.

What Is Newland Digital TechnologyLtd's Net Debt?

As you can see below, Newland Digital TechnologyLtd had CN¥1.26b of debt at June 2024, down from CN¥1.37b a year prior. But it also has CN¥4.59b in cash to offset that, meaning it has CN¥3.34b net cash.

A Look At Newland Digital TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Newland Digital TechnologyLtd had liabilities of CN¥5.52b due within 12 months and liabilities of CN¥159.2m due beyond that. On the other hand, it had cash of CN¥4.59b and CN¥2.52b worth of receivables due within a year. So it actually has CN¥1.44b more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Newland Digital TechnologyLtd has boosted its EBIT by 77%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Newland Digital TechnologyLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Newland Digital 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. Happily for any shareholders, Newland Digital TechnologyLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to investigate a company's debt, in this case Newland Digital TechnologyLtd has CN¥3.34b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥710m, being 126% of its EBIT. So we don't think Newland Digital TechnologyLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Newland Digital TechnologyLtd you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.