Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Leyard Optoelectronic Co., Ltd. (SZSE:300296) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Leyard Optoelectronic's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Leyard Optoelectronic had CN¥1.37b of debt in September 2024, down from CN¥1.56b, one year before. However, its balance sheet shows it holds CN¥2.02b in cash, so it actually has CN¥643.0m net cash.

How Healthy Is Leyard Optoelectronic's Balance Sheet?

We can see from the most recent balance sheet that Leyard Optoelectronic had liabilities of CN¥4.64b falling due within a year, and liabilities of CN¥1.28b due beyond that. Offsetting this, it had CN¥2.02b in cash and CN¥5.07b in receivables that were due within 12 months. So it can boast CN¥1.17b more liquid assets than total liabilities.

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

In fact Leyard Optoelectronic's saving grace is its low debt levels, because its EBIT has tanked 91% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Leyard Optoelectronic can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Leyard Optoelectronic 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. During the last three years, Leyard Optoelectronic generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Leyard Optoelectronic has net cash of CN¥643.0m, as well as more liquid assets than liabilities. The cherry on top was that in converted 92% of that EBIT to free cash flow, bringing in CN¥348m. So we are not troubled with Leyard Optoelectronic's debt use. 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. To that end, you should be aware of the 3 warning signs we've spotted with Leyard Optoelectronic .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.