Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Fujian Rongji Software Co., Ltd. (SZSE:002474) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Fujian Rongji Software's Debt?

You can click the graphic below for the historical numbers, but it shows that Fujian Rongji Software had CN¥604.4m of debt in September 2023, down from CN¥653.8m, one year before. However, because it has a cash reserve of CN¥168.9m, its net debt is less, at about CN¥435.5m.

How Strong Is Fujian Rongji Software's Balance Sheet?

We can see from the most recent balance sheet that Fujian Rongji Software had liabilities of CN¥1.03b falling due within a year, and liabilities of CN¥94.1m due beyond that. Offsetting these obligations, it had cash of CN¥168.9m as well as receivables valued at CN¥363.6m due within 12 months. So it has liabilities totalling CN¥589.3m more than its cash and near-term receivables, combined.

Of course, Fujian Rongji Software has a market capitalization of CN¥3.63b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujian Rongji Software will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Fujian Rongji Software had a loss before interest and tax, and actually shrunk its revenue by 10%, to CN¥585m. That's not what we would hope to see.

Caveat Emptor

Not only did Fujian Rongji Software's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥111m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥37m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. For instance, we've identified 1 warning sign for Fujian Rongji Software that 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.