Warren Buffett famously said, '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. As with many other companies Dawning Information Industry Co., Ltd. (SHSE:603019) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

What Is Dawning Information Industry's Net Debt?

As you can see below, Dawning Information Industry had CN¥2.33b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥4.84b in cash offsetting this, leading to net cash of CN¥2.51b.

A Look At Dawning Information Industry's Liabilities

We can see from the most recent balance sheet that Dawning Information Industry had liabilities of CN¥4.51b falling due within a year, and liabilities of CN¥7.76b due beyond that. Offsetting these obligations, it had cash of CN¥4.84b as well as receivables valued at CN¥4.13b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.30b.

Given Dawning Information Industry has a market capitalization of CN¥51.7b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Dawning Information Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Dawning Information Industry grew its EBIT by 13% last year, making its debt load easier to handle. 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 Dawning Information Industry'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dawning Information Industry 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, Dawning Information Industry 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 look at a company's total liabilities, it is very reassuring that Dawning Information Industry has CN¥2.51b in net cash. And it also grew its EBIT by 13% over the last year. So we are not troubled with Dawning Information Industry's debt use. 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 1 warning sign for Dawning Information Industry that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.