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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Richinfo Technology Co., Ltd. (SZSE:300634) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Richinfo Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Richinfo Technology had CN¥114.9m of debt, an increase on CN¥60.0m, over one year. But on the other hand it also has CN¥1.12b in cash, leading to a CN¥1.01b net cash position.

How Strong Is Richinfo Technology's Balance Sheet?

According to the last reported balance sheet, Richinfo Technology had liabilities of CN¥642.1m due within 12 months, and liabilities of CN¥14.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.12b as well as receivables valued at CN¥956.9m due within 12 months. So it can boast CN¥1.42b more liquid assets than total liabilities.

This surplus suggests that Richinfo Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Richinfo Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Richinfo Technology's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Richinfo Technology can strengthen its balance sheet over time. 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. Richinfo 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. Looking at the most recent three years, Richinfo Technology recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Richinfo Technology has net cash of CN¥1.01b, as well as more liquid assets than liabilities. So we are not troubled with Richinfo Technology'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. Case in point: We've spotted 3 warning signs for Richinfo Technology you should be aware of, and 1 of them is a bit concerning.

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.