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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Tong Ren Tang Technologies Co. Ltd. (HKG:1666) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Tong Ren Tang Technologies's Net Debt?

As you can see below, Tong Ren Tang Technologies had CN¥1.46b of debt, at December 2023, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has CN¥4.24b in cash, leading to a CN¥2.78b net cash position.

How Healthy Is Tong Ren Tang Technologies' Balance Sheet?

According to the last reported balance sheet, Tong Ren Tang Technologies had liabilities of CN¥2.24b due within 12 months, and liabilities of CN¥1.62b due beyond 12 months. Offsetting this, it had CN¥4.24b in cash and CN¥888.3m in receivables that were due within 12 months. So it actually has CN¥1.27b more liquid assets than total liabilities.

This surplus suggests that Tong Ren Tang Technologies is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Tong Ren Tang Technologies has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Tong Ren Tang Technologies saw its EBIT drop by 8.0% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 Tong Ren Tang Technologies 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. 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. During the last three years, Tong Ren Tang Technologies produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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¥2.78b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥884m. 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.