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.' 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. We can see that Fujian Highton Development Co., Ltd. (SHSE:603162) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Fujian Highton Development's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Fujian Highton Development had debt of CN¥50.0m, up from none in one year. But on the other hand it also has CN¥950.8m in cash, leading to a CN¥900.8m net cash position.

A Look At Fujian Highton Development's Liabilities

We can see from the most recent balance sheet that Fujian Highton Development had liabilities of CN¥480.3m falling due within a year, and liabilities of CN¥330.5m due beyond that. Offsetting this, it had CN¥950.8m in cash and CN¥375.7m in receivables that were due within 12 months. So it actually has CN¥515.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Fujian Highton Development could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Fujian Highton Development has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Fujian Highton Development if management cannot prevent a repeat of the 74% 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Fujian Highton Development 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. While Fujian Highton Development 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. Over the last three years, Fujian Highton Development reported free cash flow worth 14% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Fujian Highton Development has CN¥900.8m in net cash and a decent-looking balance sheet. So we are not troubled with Fujian Highton Development'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. To that end, you should learn about the 3 warning signs we've spotted with Fujian Highton Development (including 1 which can't be ignored) .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com