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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Hundsun Technologies Inc. (SHSE:600570) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hundsun Technologies's Debt?

As you can see below, at the end of March 2024, Hundsun Technologies had CN¥328.2m of debt, up from CN¥192.8m a year ago. Click the image for more detail. However, it does have CN¥2.68b in cash offsetting this, leading to net cash of CN¥2.35b.

A Look At Hundsun Technologies' Liabilities

We can see from the most recent balance sheet that Hundsun Technologies had liabilities of CN¥4.08b falling due within a year, and liabilities of CN¥313.4m due beyond that. Offsetting this, it had CN¥2.68b in cash and CN¥1.37b in receivables that were due within 12 months. So it has liabilities totalling CN¥349.5m more than its cash and near-term receivables, combined.

Having regard to Hundsun Technologies' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥41.1b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Hundsun Technologies also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Hundsun Technologies has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hundsun Technologies 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. Hundsun Technologies 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, Hundsun Technologies recorded free cash flow of 35% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Hundsun Technologies has CN¥2.35b in net cash. And it impressed us with its EBIT growth of 25% over the last year. So is Hundsun Technologies's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 1 warning sign for Hundsun Technologies that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.