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.' 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. Importantly, HONG RI DA Technology Company Limited (SZSE:301285) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is HONG RI DA Technology's Debt?

As you can see below, at the end of June 2024, HONG RI DA Technology had CN¥529.2m of debt, up from CN¥363.2m a year ago. Click the image for more detail. But on the other hand it also has CN¥547.9m in cash, leading to a CN¥18.7m net cash position.

How Strong Is HONG RI DA Technology's Balance Sheet?

We can see from the most recent balance sheet that HONG RI DA Technology had liabilities of CN¥844.6m falling due within a year, and liabilities of CN¥60.6m due beyond that. Offsetting these obligations, it had cash of CN¥547.9m as well as receivables valued at CN¥373.8m due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that HONG RI DA Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥4.75b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, HONG RI DA Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, HONG RI DA Technology grew its EBIT by 3,394% 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 you can't view debt in total isolation; since HONG RI DA Technology 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While HONG RI DA Technology 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, HONG RI DA Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that HONG RI DA Technology has net cash of CN¥18.7m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 3,394% over the last year. So we don't have any problem with HONG RI DA Technology's use of debt. 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. Be aware that HONG RI DA Technology is showing 2 warning signs in our investment analysis , you should know about...

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.