David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Leyard Optoelectronic Co., Ltd. (SZSE:300296) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Leyard Optoelectronic Carry?

The chart below, which you can click on for greater detail, shows that Leyard Optoelectronic had CN¥1.56b in debt in September 2023; about the same as the year before. But on the other hand it also has CN¥2.36b in cash, leading to a CN¥795.7m net cash position.

How Strong Is Leyard Optoelectronic's Balance Sheet?

The latest balance sheet data shows that Leyard Optoelectronic had liabilities of CN¥5.04b due within a year, and liabilities of CN¥1.30b falling due after that. On the other hand, it had cash of CN¥2.36b and CN¥5.68b worth of receivables due within a year. So it actually has CN¥1.70b more liquid assets than total liabilities.

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

It is just as well that Leyard Optoelectronic's load is not too heavy, because its EBIT was down 33% 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 Leyard Optoelectronic 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. While Leyard Optoelectronic has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Leyard Optoelectronic produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Leyard Optoelectronic has CN¥795.7m in net cash and a decent-looking balance sheet. So we don't have any problem with Leyard Optoelectronic'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. For example, we've discovered 3 warning signs for Leyard Optoelectronic that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.