David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Fangda Special Steel Technology Co., Ltd. (SHSE:600507) does carry debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Fangda Special Steel Technology

How Much Debt Does Fangda Special Steel Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Fangda Special Steel Technology had CN¥926.8m of debt in September 2023, down from CN¥2.30b, one year before. But on the other hand it also has CN¥9.16b in cash, leading to a CN¥8.24b net cash position.

A Look At Fangda Special Steel Technology's Liabilities

We can see from the most recent balance sheet that Fangda Special Steel Technology had liabilities of CN¥12.8b falling due within a year, and liabilities of CN¥350.4m due beyond that. On the other hand, it had cash of CN¥9.16b and CN¥2.49b worth of receivables due within a year. So it has liabilities totalling CN¥1.47b more than its cash and near-term receivables, combined.

Since publicly traded Fangda Special Steel Technology shares are worth a total of CN¥11.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Fangda Special Steel Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Fangda Special Steel Technology's saving grace is its low debt levels, because its EBIT has tanked 93% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Fangda Special Steel Technology'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Fangda Special Steel 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. Happily for any shareholders, Fangda Special Steel Technology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Fangda Special Steel Technology does have more liabilities than liquid assets, it also has net cash of CN¥8.24b. And it impressed us with free cash flow of CN¥3.6b, being 139% of its EBIT. So we are not troubled with Fangda Special Steel 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. To that end, you should be aware of the 2 warning signs we've spotted with Fangda Special Steel Technology .

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.