The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ningbo Ronbay New Energy Technology Co.,Ltd. (SHSE:688005) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Ningbo Ronbay New Energy TechnologyLtd's Debt?

As you can see below, at the end of March 2024, Ningbo Ronbay New Energy TechnologyLtd had CN¥6.73b of debt, up from CN¥5.84b a year ago. Click the image for more detail. On the flip side, it has CN¥4.87b in cash leading to net debt of about CN¥1.86b.

How Healthy Is Ningbo Ronbay New Energy TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Ningbo Ronbay New Energy TechnologyLtd had liabilities of CN¥8.34b due within 12 months, and liabilities of CN¥6.00b due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.87b as well as receivables valued at CN¥7.75b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.72b.

Since publicly traded Ningbo Ronbay New Energy TechnologyLtd shares are worth a total of CN¥15.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Ningbo Ronbay New Energy TechnologyLtd's net debt of 2.3 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.2 times its interest expenses harmonizes with that theme. Importantly, Ningbo Ronbay New Energy TechnologyLtd's EBIT fell a jaw-dropping 81% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ningbo Ronbay New Energy TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Ningbo Ronbay New Energy TechnologyLtd 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.

Our View

To be frank both Ningbo Ronbay New Energy TechnologyLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Ningbo Ronbay New Energy TechnologyLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Ningbo Ronbay New Energy TechnologyLtd you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.