Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Leedarson IoT Technology Inc. (SHSE:605365) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Leedarson IoT Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Leedarson IoT Technology had CN¥208.1m of debt in September 2023, down from CN¥340.8m, one year before. But on the other hand it also has CN¥1.60b in cash, leading to a CN¥1.39b net cash position.

How Strong Is Leedarson IoT Technology's Balance Sheet?

We can see from the most recent balance sheet that Leedarson IoT Technology had liabilities of CN¥2.22b falling due within a year, and liabilities of CN¥325.5m due beyond that. On the other hand, it had cash of CN¥1.60b and CN¥1.29b worth of receivables due within a year. So it can boast CN¥349.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Leedarson IoT Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Leedarson IoT Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Leedarson IoT Technology's saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Leedarson IoT Technology 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Leedarson IoT 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. Over the most recent three years, Leedarson IoT Technology recorded free cash flow worth 55% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Leedarson IoT Technology has CN¥1.39b in net cash and a decent-looking balance sheet. So we don't have any problem with Leedarson IoT Technology's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Leedarson IoT Technology that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.