Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Fujian Star-net Communication Co., LTD. (SZSE:002396) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, 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 Fujian Star-net Communication's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Fujian Star-net Communication had debt of CN¥1.72b, up from CN¥809.5m in one year. However, it does have CN¥3.35b in cash offsetting this, leading to net cash of CN¥1.63b.

How Healthy Is Fujian Star-net Communication's Balance Sheet?

The latest balance sheet data shows that Fujian Star-net Communication had liabilities of CN¥5.48b due within a year, and liabilities of CN¥327.6m falling due after that. Offsetting these obligations, it had cash of CN¥3.35b as well as receivables valued at CN¥2.85b due within 12 months. So it actually has CN¥397.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Fujian Star-net Communication could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Fujian Star-net Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Fujian Star-net Communication's saving grace is its low debt levels, because its EBIT has tanked 79% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fujian Star-net Communication'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 company can only pay off debt with cold hard cash, not accounting profits. While Fujian Star-net Communication 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. Over the last three years, Fujian Star-net Communication reported free cash flow worth 10% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Fujian Star-net Communication has net cash of CN¥1.63b, as well as more liquid assets than liabilities. So we are not troubled with Fujian Star-net Communication'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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Fujian Star-net Communication you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.