David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Dalian Dalicap Technology Co.,Ltd. (SZSE:301566) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Dalian Dalicap TechnologyLtd's Net Debt?

As you can see below, Dalian Dalicap TechnologyLtd had CN¥100.0m of debt at March 2024, down from CN¥149.9m a year prior. However, its balance sheet shows it holds CN¥914.9m in cash, so it actually has CN¥814.8m net cash.

How Healthy Is Dalian Dalicap TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Dalian Dalicap TechnologyLtd had liabilities of CN¥83.0m due within 12 months, and liabilities of CN¥101.7m due beyond 12 months. On the other hand, it had cash of CN¥914.9m and CN¥117.1m worth of receivables due within a year. So it actually has CN¥847.2m more liquid assets than total liabilities.

This surplus suggests that Dalian Dalicap TechnologyLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Dalian Dalicap TechnologyLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Dalian Dalicap TechnologyLtd if management cannot prevent a repeat of the 32% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Dalian Dalicap TechnologyLtd 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. While Dalian Dalicap TechnologyLtd 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. During the last three years, Dalian Dalicap TechnologyLtd produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Dalian Dalicap TechnologyLtd has net cash of CN¥814.8m, as well as more liquid assets than liabilities. So we are not troubled with Dalian Dalicap TechnologyLtd's debt use. 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 1 warning sign with Dalian Dalicap TechnologyLtd , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.