Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Focus Media Information Technology Co., Ltd. (SZSE:002027) does carry debt. But should shareholders be worried about its use of debt?
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. 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 think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Focus Media Information Technology
What Is Focus Media Information Technology's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Focus Media Information Technology had debt of CN¥2.31b, up from CN¥13.0m in one year. But it also has CN¥7.26b in cash to offset that, meaning it has CN¥4.94b net cash.
How Strong Is Focus Media Information Technology's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Focus Media Information Technology had liabilities of CN¥4.96b due within 12 months and liabilities of CN¥1.15b due beyond that. Offsetting this, it had CN¥7.26b in cash and CN¥2.02b in receivables that were due within 12 months. So it can boast CN¥3.16b more liquid assets than total liabilities.
This short term liquidity is a sign that Focus Media Information Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Focus Media Information Technology has more cash than debt is arguably a good indication that it can manage its debt safely.
The good news is that Focus Media Information Technology has increased its EBIT by 8.0% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Focus Media Information Technology can strengthen its balance sheet over time. 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. Focus Media Information Technology 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. Happily for any shareholders, Focus Media Information Technology actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Focus Media Information Technology has net cash of CN¥4.94b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥7.2b, being 157% of its EBIT. So is Focus Media Information Technology's debt a risk? It doesn't seem so to us. 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 1 warning sign for Focus Media Information Technology that you should be aware of before investing here.
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.