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 note that Hangzhou Hikvision Digital Technology Co., Ltd. (SZSE:002415) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Hangzhou Hikvision Digital Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Hangzhou Hikvision Digital Technology had CN¥16.5b of debt, an increase on CN¥14.2b, over one year. However, it does have CN¥44.1b in cash offsetting this, leading to net cash of CN¥27.6b.

How Healthy Is Hangzhou Hikvision Digital Technology's Balance Sheet?

The latest balance sheet data shows that Hangzhou Hikvision Digital Technology had liabilities of CN¥38.4b due within a year, and liabilities of CN¥9.24b falling due after that. Offsetting this, it had CN¥44.1b in cash and CN¥40.8b in receivables that were due within 12 months. So it actually has CN¥37.3b more liquid assets than total liabilities.

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

Also positive, Hangzhou Hikvision Digital Technology grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Hangzhou Hikvision Digital 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hangzhou Hikvision Digital Technology 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. Over the most recent three years, Hangzhou Hikvision Digital Technology recorded free cash flow worth 58% 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 Hangzhou Hikvision Digital Technology has CN¥27.6b in net cash and a decent-looking balance sheet. And we liked the look of last year's 21% year-on-year EBIT growth. So we don't think Hangzhou Hikvision Digital Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hangzhou Hikvision Digital Technology 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.