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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Levima Advanced Materials Corporation (SZSE:003022) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Levima Advanced Materials Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Levima Advanced Materials had debt of CN¥9.08b, up from CN¥6.55b in one year. However, because it has a cash reserve of CN¥2.43b, its net debt is less, at about CN¥6.65b.

How Strong Is Levima Advanced Materials' Balance Sheet?

According to the last reported balance sheet, Levima Advanced Materials had liabilities of CN¥5.71b due within 12 months, and liabilities of CN¥5.22b due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.43b as well as receivables valued at CN¥248.9m due within 12 months. So its liabilities total CN¥8.25b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Levima Advanced Materials has a market capitalization of CN¥19.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Levima Advanced Materials will need earnings to service that debt. 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.

In the last year Levima Advanced Materials's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Levima Advanced Materials had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥57m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥2.4b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Levima Advanced Materials you should be aware of, and 2 of them can't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.