Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Fujian Boss Software Corp. (SZSE:300525) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Fujian Boss Software's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Fujian Boss Software had debt of CN¥380.7m, up from CN¥218.0m in one year. However, its balance sheet shows it holds CN¥1.10b in cash, so it actually has CN¥717.6m net cash.

How Healthy Is Fujian Boss Software's Balance Sheet?

The latest balance sheet data shows that Fujian Boss Software had liabilities of CN¥865.9m due within a year, and liabilities of CN¥399.8m falling due after that. Offsetting this, it had CN¥1.10b in cash and CN¥1.20b in receivables that were due within 12 months. So it can boast CN¥1.03b more liquid assets than total liabilities.

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

Also positive, Fujian Boss Software grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. 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 Fujian Boss Software 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. While Fujian Boss Software 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. In the last three years, Fujian Boss Software created free cash flow amounting to 17% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Fujian Boss Software has CN¥717.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 27% over the last year. So we don't think Fujian Boss Software's use of debt 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 Boss Software 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.