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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Focus Lightings Tech Co., Ltd. (SZSE:300708) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Focus Lightings Tech's Debt?

As you can see below, Focus Lightings Tech had CN¥796.0m 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¥2.11b in cash to offset that, meaning it has CN¥1.31b net cash.

How Healthy Is Focus Lightings Tech's Balance Sheet?

The latest balance sheet data shows that Focus Lightings Tech had liabilities of CN¥2.13b due within a year, and liabilities of CN¥105.0k falling due after that. Offsetting this, it had CN¥2.11b in cash and CN¥688.4m in receivables that were due within 12 months. So it can boast CN¥667.5m more liquid assets than total liabilities.

This surplus suggests that Focus Lightings Tech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Focus Lightings Tech has more cash than debt is arguably a good indication that it can manage its debt safely.

Although Focus Lightings Tech made a loss at the EBIT level, last year, it was also good to see that it generated CN¥160m in EBIT over the last twelve months. 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 Focus Lightings Tech'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 Focus Lightings Tech 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. In the last year, Focus Lightings Tech's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Focus Lightings Tech has net cash of CN¥1.31b, as well as more liquid assets than liabilities. So we are not troubled with Focus Lightings Tech's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Focus Lightings Tech 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.