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.' 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. We note that Lucky Film Company Limited (SHSE:600135) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Lucky Film's Net Debt?

As you can see below, Lucky Film had CN¥78.3m of debt, at September 2024, which is about the same as the year before. You can click the chart for greater detail. But it also has CN¥808.3m in cash to offset that, meaning it has CN¥730.0m net cash.

How Healthy Is Lucky Film's Balance Sheet?

According to the last reported balance sheet, Lucky Film had liabilities of CN¥364.8m due within 12 months, and liabilities of CN¥89.5m due beyond 12 months. On the other hand, it had cash of CN¥808.3m and CN¥379.6m worth of receivables due within a year. So it actually has CN¥733.6m more liquid assets than total liabilities.

It's good to see that Lucky Film has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Lucky Film has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Lucky Film's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Lucky Film made a loss at the EBIT level, and saw its revenue drop to CN¥1.6b, which is a fall of 26%. To be frank that doesn't bode well.

So How Risky Is Lucky Film?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Lucky Film lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥157m and booked a CN¥117m accounting loss. Given it only has net cash of CN¥730.0m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. For example, we've discovered 1 warning sign for Lucky Film 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.