Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, iRay Technology Company Limited (SHSE:688301) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does iRay Technology Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 iRay Technology had CN¥1.52b of debt, an increase on CN¥1.31b, over one year. But on the other hand it also has CN¥2.28b in cash, leading to a CN¥761.1m net cash position.
A Look At iRay Technology's Liabilities
The latest balance sheet data shows that iRay Technology had liabilities of CN¥460.1m due within a year, and liabilities of CN¥1.53b falling due after that. Offsetting these obligations, it had cash of CN¥2.28b as well as receivables valued at CN¥750.6m due within 12 months. So it actually has CN¥1.04b more liquid assets than total liabilities.
This surplus suggests that iRay Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that iRay Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
In addition to that, we're happy to report that iRay Technology has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. 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 iRay Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. iRay 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. During the last three years, iRay Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
Summing Up
While it is always sensible to investigate a company's debt, in this case iRay Technology has CN¥761.1m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 42% over the last year. So we don't think iRay Technology's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for iRay Technology 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.