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.' 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 can see that Huitongda Network Co., Ltd. (HKG:9878) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Huitongda Network's Net Debt?

As you can see below, Huitongda Network had CN¥1.65b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥7.98b in cash, leading to a CN¥6.33b net cash position.

How Strong Is Huitongda Network's Balance Sheet?

According to the last reported balance sheet, Huitongda Network had liabilities of CN¥20.6b due within 12 months, and liabilities of CN¥267.7m due beyond 12 months. On the other hand, it had cash of CN¥7.98b and CN¥3.35b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥9.58b.

This deficit is considerable relative to its market capitalization of CN¥9.61b, so it does suggest shareholders should keep an eye on Huitongda Network's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Huitongda Network boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Huitongda Network has increased its EBIT by 7.8% 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 ultimately the future profitability of the business will decide if Huitongda Network 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Huitongda Network 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 last three years, Huitongda Network 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

Although Huitongda Network's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥6.33b. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in CN¥438m. So we don't have any problem with Huitongda Network's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Huitongda Network that 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.