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 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 Nanjing LES Information Technology Co., Ltd. (SHSE:688631) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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.

What Is Nanjing LES Information Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that Nanjing LES Information Technology had CN¥81.2m of debt in September 2023, down from CN¥217.0m, one year before. However, it does have CN¥1.08b in cash offsetting this, leading to net cash of CN¥1.00b.

How Strong Is Nanjing LES Information Technology's Balance Sheet?

According to the last reported balance sheet, Nanjing LES Information Technology had liabilities of CN¥1.52b due within 12 months, and liabilities of CN¥49.5m due beyond 12 months. On the other hand, it had cash of CN¥1.08b and CN¥1.43b worth of receivables due within a year. So it can boast CN¥941.0m more liquid assets than total liabilities.

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

On top of that, Nanjing LES Information Technology grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Nanjing LES Information Technology will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Nanjing LES Information 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. Looking at the most recent three years, Nanjing LES Information Technology recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Nanjing LES Information Technology has net cash of CN¥1.00b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 54% over the last year. So is Nanjing LES Information Technology's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Nanjing LES Information Technology that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.