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. We can see that Naruida Technology Co., Ltd. (SHSE:688522) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Naruida Technology's Net Debt?

As you can see below, Naruida Technology had CN¥60.0m of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥1.64b in cash offsetting this, leading to net cash of CN¥1.58b.

A Look At Naruida Technology's Liabilities

The latest balance sheet data shows that Naruida Technology had liabilities of CN¥130.9m due within a year, and liabilities of CN¥16.9m falling due after that. Offsetting this, it had CN¥1.64b in cash and CN¥314.0m in receivables that were due within 12 months. So it can boast CN¥1.80b more liquid assets than total liabilities.

This surplus suggests that Naruida Technology is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Naruida Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Naruida Technology's saving grace is its low debt levels, because its EBIT has tanked 80% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Naruida Technology 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Naruida Technology 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. Over the last three years, Naruida Technology saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Naruida Technology has CN¥1.58b in net cash and a decent-looking balance sheet. So we don't have any problem with Naruida Technology's use of debt. 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, we've discovered 2 warning signs for Naruida Technology (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.