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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sun.King Technology Group Limited (HKG:580) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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.

Check out our latest analysis for Sun.King Technology Group

What Is Sun.King Technology Group's Debt?

As you can see below, Sun.King Technology Group had CN¥200.6m of debt at June 2022, down from CN¥312.1m a year prior. But on the other hand it also has CN¥652.4m in cash, leading to a CN¥451.9m net cash position.

How Strong Is Sun.King Technology Group's Balance Sheet?

The latest balance sheet data shows that Sun.King Technology Group had liabilities of CN¥431.6m due within a year, and liabilities of CN¥176.6m falling due after that. Offsetting this, it had CN¥652.4m in cash and CN¥765.5m in receivables that were due within 12 months. So it actually has CN¥809.7m more liquid assets than total liabilities.

This luscious liquidity implies that Sun.King Technology Group's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Sun.King Technology Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sun.King Technology Group's load is not too heavy, because its EBIT was down 91% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sun.King Technology Group will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sun.King Technology Group 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, Sun.King Technology Group reported free cash flow worth 8.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sun.King Technology Group has net cash of CN¥451.9m, as well as more liquid assets than liabilities. So we are not troubled with Sun.King Technology Group's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Sun.King Technology Group (1 can't be ignored!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.