David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, LAPLACE Renewable Energy Technology Co., Ltd. (SHSE:688726) does carry debt. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is LAPLACE Renewable Energy Technology's Net Debt?

The image below, which you can click on for greater detail, shows that LAPLACE Renewable Energy Technology had debt of CN¥233.4m at the end of September 2024, a reduction from CN¥263.3m over a year. But on the other hand it also has CN¥931.4m in cash, leading to a CN¥698.0m net cash position.

How Healthy Is LAPLACE Renewable Energy Technology's Balance Sheet?

According to the last reported balance sheet, LAPLACE Renewable Energy Technology had liabilities of CN¥7.06b due within 12 months, and liabilities of CN¥176.6m due beyond 12 months. On the other hand, it had cash of CN¥931.4m and CN¥2.00b worth of receivables due within a year. So its liabilities total CN¥4.31b more than the combination of its cash and short-term receivables.

LAPLACE Renewable Energy Technology has a market capitalization of CN¥17.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, LAPLACE Renewable Energy Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that LAPLACE Renewable Energy Technology grew its EBIT by 198% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 LAPLACE Renewable Energy Technology 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. LAPLACE Renewable Energy Technology 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. In the last three years, LAPLACE Renewable Energy Technology's free cash flow amounted to 26% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While LAPLACE Renewable Energy Technology does have more liabilities than liquid assets, it also has net cash of CN¥698.0m. And we liked the look of last year's 198% year-on-year EBIT growth. So we don't have any problem with LAPLACE Renewable Energy Technology's use of debt. 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. Case in point: We've spotted 2 warning signs for LAPLACE Renewable Energy Technology you should be aware of, and 1 of them makes us a bit uncomfortable.

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.