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 note that Fujian Star-net Communication Co., LTD. (SZSE:002396) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for Fujian Star-net Communication

What Is Fujian Star-net Communication's Debt?

As you can see below, at the end of September 2023, Fujian Star-net Communication had CN¥840.7m of debt, up from CN¥666.9m a year ago. Click the image for more detail. However, it does have CN¥3.65b in cash offsetting this, leading to net cash of CN¥2.81b.

How Strong Is Fujian Star-net Communication's Balance Sheet?

According to the last reported balance sheet, Fujian Star-net Communication had liabilities of CN¥5.35b due within 12 months, and liabilities of CN¥412.3m due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.65b as well as receivables valued at CN¥2.90b due within 12 months. So it can boast CN¥795.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Fujian Star-net Communication could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Fujian Star-net Communication has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Fujian Star-net Communication's saving grace is its low debt levels, because its EBIT has tanked 74% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Fujian Star-net 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Fujian Star-net Communication 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. During the last three years, Fujian Star-net Communication produced sturdy free cash flow equating to 64% 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 Fujian Star-net Communication has CN¥2.81b in net cash and a decent-looking balance sheet. So we are not troubled with Fujian Star-net Communication'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 - Fujian Star-net Communication has 3 warning signs we think you should be aware of.

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.