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 Shenzhen Longli Technology Co.,Ltd (SZSE:300752) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Shenzhen Longli TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Longli TechnologyLtd had CN¥43.0m of debt in September 2024, down from CN¥136.4m, one year before. But it also has CN¥464.4m in cash to offset that, meaning it has CN¥421.4m net cash.

How Healthy Is Shenzhen Longli TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shenzhen Longli TechnologyLtd had liabilities of CN¥678.7m due within 12 months, and liabilities of CN¥53.7m due beyond 12 months. On the other hand, it had cash of CN¥464.4m and CN¥596.1m worth of receivables due within a year. So it actually has CN¥328.0m more liquid assets than total liabilities.

This surplus suggests that Shenzhen Longli TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Shenzhen Longli TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Shenzhen Longli TechnologyLtd turned things around in the last 12 months, delivering and EBIT of CN¥127m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shenzhen Longli TechnologyLtd 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. Shenzhen Longli TechnologyLtd 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 year, Shenzhen Longli TechnologyLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Longli TechnologyLtd has CN¥421.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥152m, being 119% of its EBIT. So we don't think Shenzhen Longli TechnologyLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. 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 Shenzhen Longli TechnologyLtd you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.