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.' 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 note that Fujian Boss Software Corp. (SZSE:300525) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.
What Is Fujian Boss Software's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2023 Fujian Boss Software had CN¥218.0m of debt, an increase on CN¥124.3m, over one year. However, it does have CN¥1.15b in cash offsetting this, leading to net cash of CN¥929.2m.
A Look At Fujian Boss Software's Liabilities
According to the last reported balance sheet, Fujian Boss Software had liabilities of CN¥562.2m due within 12 months, and liabilities of CN¥260.6m due beyond 12 months. On the other hand, it had cash of CN¥1.15b and CN¥1.14b worth of receivables due within a year. So it can boast CN¥1.46b more liquid assets than total liabilities.
This surplus suggests that Fujian Boss Software has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Fujian Boss Software has more cash than debt is arguably a good indication that it can manage its debt safely.
But the other side of the story is that Fujian Boss Software saw its EBIT decline by 2.6% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fujian Boss Software'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fujian Boss Software 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. In the last three years, Fujian Boss Software's free cash flow amounted to 21% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
Summing Up
While it is always sensible to investigate a company's debt, in this case Fujian Boss Software has CN¥929.2m in net cash and a decent-looking balance sheet. So we are not troubled with Fujian Boss Software's debt use. 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. Be aware that Fujian Boss Software is showing 2 warning signs in our investment analysis , and 1 of those is a bit concerning...
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.