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.' 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. As with many other companies Suntak Technology Co.,Ltd. (SZSE:002815) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Suntak TechnologyLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Suntak TechnologyLtd had CN¥2.28b of debt, an increase on CN¥1.86b, over one year. However, its balance sheet shows it holds CN¥3.05b in cash, so it actually has CN¥772.4m net cash.

A Look At Suntak TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Suntak TechnologyLtd had liabilities of CN¥2.74b due within 12 months and liabilities of CN¥1.90b due beyond that. Offsetting these obligations, it had cash of CN¥3.05b as well as receivables valued at CN¥1.83b due within 12 months. So it actually has CN¥241.2m more liquid assets than total liabilities.

This surplus suggests that Suntak TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Suntak TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Suntak TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 40% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Suntak 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Suntak 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, Suntak TechnologyLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Suntak TechnologyLtd has CN¥772.4m in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Suntak TechnologyLtd's balance sheet. 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. Case in point: We've spotted 3 warning signs for Suntak TechnologyLtd you should be aware of, and 1 of them can't be ignored.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.