The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Suzhou TFC Optical Communication Co., Ltd. (SZSE:300394) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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.
How Much Debt Does Suzhou TFC Optical Communication Carry?
The image below, which you can click on for greater detail, shows that at March 2024 Suzhou TFC Optical Communication had debt of CN¥40.0m, up from none in one year. However, its balance sheet shows it holds CN¥2.40b in cash, so it actually has CN¥2.36b net cash.
How Strong Is Suzhou TFC Optical Communication's Balance Sheet?
We can see from the most recent balance sheet that Suzhou TFC Optical Communication had liabilities of CN¥493.0m falling due within a year, and liabilities of CN¥29.5m due beyond that. On the other hand, it had cash of CN¥2.40b and CN¥592.4m worth of receivables due within a year. So it can boast CN¥2.47b more liquid assets than total liabilities.
This surplus suggests that Suzhou TFC Optical Communication has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Suzhou TFC Optical Communication has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Suzhou TFC Optical Communication grew its EBIT by 148% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Suzhou TFC Optical Communication's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Suzhou TFC Optical Communication 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, Suzhou TFC Optical Communication produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Summing Up
While it is always sensible to investigate a company's debt, in this case Suzhou TFC Optical Communication has CN¥2.36b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 148% over the last year. So is Suzhou TFC Optical Communication's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Suzhou TFC Optical Communication (2 make us uncomfortable) you should be aware of.
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.