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 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. Importantly, Digital China Information Service Company Ltd. (SZSE:000555) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Digital China Information Service

What Is Digital China Information Service's Debt?

As you can see below, Digital China Information Service had CN¥232.7m of debt at June 2022, down from CN¥414.9m a year prior. However, its balance sheet shows it holds CN¥1.36b in cash, so it actually has CN¥1.13b net cash.

A Look At Digital China Information Service's Liabilities

We can see from the most recent balance sheet that Digital China Information Service had liabilities of CN¥5.49b falling due within a year, and liabilities of CN¥171.2m due beyond that. Offsetting these obligations, it had cash of CN¥1.36b as well as receivables valued at CN¥4.31b due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Digital China Information Service's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥9.04b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Digital China Information Service boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Digital China Information Service has seen its EBIT plunge 17% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Digital China Information Service's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Digital China Information Service 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 most recent three years, Digital China Information Service recorded free cash flow worth 65% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Digital China Information Service has net cash of CN¥1.13b, as well as more liquid assets than liabilities. So we don't have any problem with Digital China Information Service's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Digital China Information Service you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.