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. Importantly, Wuxi Longsheng Technology Co.,Ltd (SZSE:300680) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Wuxi Longsheng TechnologyLtd Carry?

As you can see below, at the end of September 2024, Wuxi Longsheng TechnologyLtd had CN¥1.22b of debt, up from CN¥935.9m a year ago. Click the image for more detail. On the flip side, it has CN¥672.0m in cash leading to net debt of about CN¥552.3m.

How Healthy Is Wuxi Longsheng TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Wuxi Longsheng TechnologyLtd had liabilities of CN¥1.61b due within a year, and liabilities of CN¥311.4m falling due after that. On the other hand, it had cash of CN¥672.0m and CN¥827.6m worth of receivables due within a year. So its liabilities total CN¥420.8m more than the combination of its cash and short-term receivables.

Of course, Wuxi Longsheng TechnologyLtd has a market capitalization of CN¥5.65b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Wuxi Longsheng TechnologyLtd's net debt to EBITDA ratio of about 1.8 suggests only moderate use of debt. And its strong interest cover of 13.2 times, makes us even more comfortable. Pleasingly, Wuxi Longsheng TechnologyLtd is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 104% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Wuxi Longsheng TechnologyLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Wuxi Longsheng TechnologyLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Wuxi Longsheng TechnologyLtd's impressive interest cover implies it has the upper hand on its debt. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Wuxi Longsheng TechnologyLtd can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Wuxi Longsheng TechnologyLtd that you should be aware of.

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.