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. As with many other companies Novoray Corporation (SHSE:688300) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

What Is Novoray's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Novoray had CN¥89.2m of debt, an increase on CN¥400.0k, over one year. However, its balance sheet shows it holds CN¥565.1m in cash, so it actually has CN¥475.9m net cash.

How Healthy Is Novoray's Balance Sheet?

We can see from the most recent balance sheet that Novoray had liabilities of CN¥250.5m falling due within a year, and liabilities of CN¥156.8m due beyond that. Offsetting these obligations, it had cash of CN¥565.1m as well as receivables valued at CN¥296.4m due within 12 months. So it actually has CN¥454.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Novoray could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Novoray boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Novoray has increased its EBIT by 3.0% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Novoray's ability to maintain a healthy balance sheet going forward. 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. Novoray 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, Novoray recorded free cash flow of 44% 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 Novoray has net cash of CN¥475.9m, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 3.0% in the last twelve months. So we are not troubled with Novoray's debt use. 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. Case in point: We've spotted 1 warning sign for Novoray you should be aware of.

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.