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 Datang Telecom Technology Co., Ltd. (SHSE:600198) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Datang Telecom Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Datang Telecom Technology had CN¥250.6m of debt, an increase on CN¥158.7m, over one year. But on the other hand it also has CN¥261.7m in cash, leading to a CN¥11.1m net cash position.

How Healthy Is Datang Telecom Technology's Balance Sheet?

We can see from the most recent balance sheet that Datang Telecom Technology had liabilities of CN¥1.12b falling due within a year, and liabilities of CN¥939.1m due beyond that. Offsetting these obligations, it had cash of CN¥261.7m as well as receivables valued at CN¥909.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥890.8m.

Since publicly traded Datang Telecom Technology shares are worth a total of CN¥15.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Datang Telecom Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Datang Telecom Technology made a loss at the EBIT level, last year, it was also good to see that it generated CN¥40m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Datang Telecom Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Datang Telecom 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. Over the last year, Datang Telecom Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Datang Telecom Technology has CN¥11.1m in net cash. So we are not troubled with Datang Telecom Technology's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Datang Telecom Technology you should be aware of.

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.