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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Luenmei Quantum Co.,Ltd (SHSE:600167) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Luenmei QuantumLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Luenmei QuantumLtd had CN¥2.00b of debt in March 2024, down from CN¥2.12b, one year before. However, it does have CN¥8.05b in cash offsetting this, leading to net cash of CN¥6.05b.

A Look At Luenmei QuantumLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Luenmei QuantumLtd had liabilities of CN¥3.54b due within 12 months and liabilities of CN¥1.78b due beyond that. Offsetting this, it had CN¥8.05b in cash and CN¥1.11b in receivables that were due within 12 months. So it can boast CN¥3.84b more liquid assets than total liabilities.

This excess liquidity suggests that Luenmei QuantumLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, Luenmei QuantumLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Luenmei QuantumLtd has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Luenmei QuantumLtd can strengthen its balance sheet over time. 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. Luenmei QuantumLtd 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. Over the last three years, Luenmei QuantumLtd actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Luenmei QuantumLtd has CN¥6.05b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥1.3b, being 133% of its EBIT. So we don't think Luenmei QuantumLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Luenmei QuantumLtd you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.