Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies 3onedata Co., Ltd. (SHSE:688618) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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 3onedata Carry?

The image below, which you can click on for greater detail, shows that at December 2023 3onedata had debt of CN¥93.5m, up from CN¥76.2m in one year. But on the other hand it also has CN¥474.4m in cash, leading to a CN¥380.9m net cash position.

How Healthy Is 3onedata's Balance Sheet?

We can see from the most recent balance sheet that 3onedata had liabilities of CN¥185.9m falling due within a year, and liabilities of CN¥3.83m due beyond that. On the other hand, it had cash of CN¥474.4m and CN¥252.9m worth of receivables due within a year. So it actually has CN¥537.7m more liquid assets than total liabilities.

This surplus suggests that 3onedata has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that 3onedata has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, 3onedata grew its EBIT by 56% over the last twelve months, and that growth will make it easier to handle its 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 3onedata can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 3onedata 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. During the last three years, 3onedata burned a lot of cash. 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 we empathize with investors who find debt concerning, you should keep in mind that 3onedata has net cash of CN¥380.9m, as well as more liquid assets than liabilities. And we liked the look of last year's 56% year-on-year EBIT growth. So we don't have any problem with 3onedata'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 3onedata , and understanding them should be part of your investment process.

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.