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.' 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 note that Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tong Ren Tang Technologies

What Is Tong Ren Tang Technologies's Debt?

As you can see below, Tong Ren Tang Technologies had CN¥1.50b of debt at June 2022, down from CN¥2.34b a year prior. However, its balance sheet shows it holds CN¥4.31b in cash, so it actually has CN¥2.82b net cash.

A Look At Tong Ren Tang Technologies' Liabilities

We can see from the most recent balance sheet that Tong Ren Tang Technologies had liabilities of CN¥2.78b falling due within a year, and liabilities of CN¥1.16b due beyond that. Offsetting these obligations, it had cash of CN¥4.31b as well as receivables valued at CN¥1.53b due within 12 months. So it can boast CN¥1.90b more liquid assets than total liabilities.

This surplus strongly suggests that Tong Ren Tang Technologies has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Tong Ren Tang Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

While Tong Ren Tang Technologies doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. 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 Tong Ren Tang Technologies'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, a company can only pay off debt with cold hard cash, not accounting profits. Tong Ren Tang 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. In the last three years, Tong Ren Tang Technologies's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tong Ren Tang Technologies has net cash of CN¥2.82b, as well as more liquid assets than liabilities. So we don't think Tong Ren Tang Technologies's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Tong Ren Tang Technologies's dividend history, without delay!

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.