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 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 FangDa Carbon New Material Co.,Ltd (SHSE:600516) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. 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 FangDa Carbon New MaterialLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 FangDa Carbon New MaterialLtd had CN¥1.41b of debt, an increase on CN¥1.08b, over one year. But on the other hand it also has CN¥7.11b in cash, leading to a CN¥5.70b net cash position.

How Strong Is FangDa Carbon New MaterialLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that FangDa Carbon New MaterialLtd had liabilities of CN¥2.35b due within 12 months and liabilities of CN¥1.07b due beyond that. Offsetting this, it had CN¥7.11b in cash and CN¥2.11b in receivables that were due within 12 months. So it actually has CN¥5.80b more liquid assets than total liabilities.

This surplus liquidity suggests that FangDa Carbon New MaterialLtd's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, FangDa Carbon New MaterialLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact FangDa Carbon New MaterialLtd's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 FangDa Carbon New MaterialLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While FangDa Carbon New MaterialLtd 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, FangDa Carbon New MaterialLtd's free cash flow amounted to 27% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case FangDa Carbon New MaterialLtd has CN¥5.70b in net cash and a decent-looking balance sheet. So we don't have any problem with FangDa Carbon New MaterialLtd's use of debt. 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. We've identified 2 warning signs with FangDa Carbon New MaterialLtd , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com