Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Jiangsu Leili Motor Co., Ltd (SZSE:300660) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Jiangsu Leili Motor Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Jiangsu Leili Motor had CN¥825.0m of debt, an increase on CN¥269.7m, over one year. But on the other hand it also has CN¥1.93b in cash, leading to a CN¥1.10b net cash position.

A Look At Jiangsu Leili Motor's Liabilities

The latest balance sheet data shows that Jiangsu Leili Motor had liabilities of CN¥2.33b due within a year, and liabilities of CN¥65.5m falling due after that. Offsetting these obligations, it had cash of CN¥1.93b as well as receivables valued at CN¥1.55b due within 12 months. So it actually has CN¥1.08b more liquid assets than total liabilities.

This short term liquidity is a sign that Jiangsu Leili Motor could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Jiangsu Leili Motor boasts net cash, so it's fair to say it does not have a heavy debt load!

Jiangsu Leili Motor's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Jiangsu Leili Motor 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. Jiangsu Leili Motor 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. Over the last three years, Jiangsu Leili Motor saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jiangsu Leili Motor has net cash of CN¥1.10b, as well as more liquid assets than liabilities. So we are not troubled with Jiangsu Leili Motor's debt use. 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. We've identified 2 warning signs with Jiangsu Leili Motor (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.