Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Tiangong International Company Limited (HKG:826) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Tiangong International

How Much Debt Does Tiangong International Carry?

The chart below, which you can click on for greater detail, shows that Tiangong International had CN¥2.78b in debt in June 2022; about the same as the year before. However, it does have CN¥2.80b in cash offsetting this, leading to net cash of CN¥24.2m.

A Look At Tiangong International's Liabilities

Zooming in on the latest balance sheet data, we can see that Tiangong International had liabilities of CN¥4.83b due within 12 months and liabilities of CN¥1.31b due beyond that. Offsetting these obligations, it had cash of CN¥2.80b as well as receivables valued at CN¥2.50b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥834.4m.

Since publicly traded Tiangong International shares are worth a total of CN¥6.13b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Tiangong International also has more cash than debt, so we're pretty confident it can manage its debt safely.

Tiangong International's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Tiangong International'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tiangong International 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, Tiangong International recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While Tiangong International does have more liabilities than liquid assets, it also has net cash of CN¥24.2m. So we are not troubled with Tiangong International's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Tiangong International insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.