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. As with many other companies Xgimi Technology Co.,Ltd. (SHSE:688696) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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 Xgimi TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Xgimi TechnologyLtd had CN¥660.3m of debt, an increase on CN¥300.0m, over one year. However, its balance sheet shows it holds CN¥2.32b in cash, so it actually has CN¥1.66b net cash.

A Look At Xgimi TechnologyLtd's Liabilities

The latest balance sheet data shows that Xgimi TechnologyLtd had liabilities of CN¥1.14b due within a year, and liabilities of CN¥1.15b falling due after that. Offsetting these obligations, it had cash of CN¥2.32b as well as receivables valued at CN¥166.3m due within 12 months. So it can boast CN¥190.9m more liquid assets than total liabilities.

This surplus suggests that Xgimi TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Xgimi TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Xgimi TechnologyLtd's load is not too heavy, because its EBIT was down 92% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Xgimi 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. Xgimi TechnologyLtd 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, Xgimi TechnologyLtd's free cash flow amounted to 43% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Xgimi TechnologyLtd has net cash of CN¥1.66b, as well as more liquid assets than liabilities. So we don't have any problem with Xgimi TechnologyLtd'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. Be aware that Xgimi TechnologyLtd is showing 2 warning signs in our investment analysis , you should know about...

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.