The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Cofoe Medical Technology Co.,Ltd. (SZSE:301087) 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 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 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Cofoe Medical TechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Cofoe Medical TechnologyLtd had CN¥847.9m of debt, an increase on CN¥485.6m, over one year. However, its balance sheet shows it holds CN¥2.66b in cash, so it actually has CN¥1.81b net cash.

A Look At Cofoe Medical TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Cofoe Medical TechnologyLtd had liabilities of CN¥1.42b due within 12 months and liabilities of CN¥301.0m due beyond that. On the other hand, it had cash of CN¥2.66b and CN¥477.8m worth of receivables due within a year. So it can boast CN¥1.41b more liquid assets than total liabilities.

It's good to see that Cofoe Medical TechnologyLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Cofoe Medical TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Cofoe Medical TechnologyLtd's load is not too heavy, because its EBIT was down 42% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Cofoe Medical TechnologyLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Cofoe Medical TechnologyLtd 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, Cofoe Medical TechnologyLtd saw substantial negative free cash flow, in total. 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 Cofoe Medical TechnologyLtd has net cash of CN¥1.81b, as well as more liquid assets than liabilities. So we don't have any problem with Cofoe Medical TechnologyLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Cofoe Medical TechnologyLtd , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.