David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. Importantly, Tongding Interconnection Information Co., Ltd. (SZSE:002491) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Tongding Interconnection Information

How Much Debt Does Tongding Interconnection Information Carry?

You can click the graphic below for the historical numbers, but it shows that Tongding Interconnection Information had CN¥2.00b of debt in September 2023, down from CN¥3.05b, one year before. However, because it has a cash reserve of CN¥1.71b, its net debt is less, at about CN¥286.0m.

How Healthy Is Tongding Interconnection Information's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Tongding Interconnection Information had liabilities of CN¥3.51b due within 12 months and liabilities of CN¥71.1m due beyond that. On the other hand, it had cash of CN¥1.71b and CN¥1.47b worth of receivables due within a year. So it has liabilities totalling CN¥398.7m more than its cash and near-term receivables, combined.

Since publicly traded Tongding Interconnection Information shares are worth a total of CN¥7.13b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Tongding Interconnection Information has a low net debt to EBITDA ratio of only 0.87. And its EBIT covers its interest expense a whopping 14.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Although Tongding Interconnection Information made a loss at the EBIT level, last year, it was also good to see that it generated CN¥292m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tongding Interconnection Information 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Tongding Interconnection Information recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, Tongding Interconnection Information's impressive interest cover implies it has the upper hand on its debt. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Tongding Interconnection Information's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Tongding Interconnection Information .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.