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 note that Richinfo Technology Co., Ltd. (SZSE:300634) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Richinfo Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Richinfo Technology had CN¥57.0m of debt in December 2023, down from CN¥62.4m, one year before. But it also has CN¥1.29b in cash to offset that, meaning it has CN¥1.23b net cash.

How Strong Is Richinfo Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Richinfo Technology had liabilities of CN¥524.5m due within 12 months and liabilities of CN¥38.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.29b as well as receivables valued at CN¥717.8m due within 12 months. So it actually has CN¥1.44b more liquid assets than total liabilities.

This excess liquidity suggests that Richinfo Technology is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Richinfo Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Richinfo Technology grew its EBIT at 12% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Richinfo Technology 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 Richinfo Technology 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, Richinfo Technology's free cash flow amounted to 43% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Richinfo Technology has net cash of CN¥1.23b, as well as more liquid assets than liabilities. On top of that, it increased its EBIT by 12% in the last twelve months. So we don't think Richinfo Technology's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Richinfo Technology that you should be aware of before investing here.

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.