Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 China United Network Communications Limited (SHSE:600050) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is China United Network Communications's Debt?

As you can see below, at the end of March 2024, China United Network Communications had CN¥16.1b of debt, up from CN¥15.2b a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥59.7b in cash, so it actually has CN¥43.6b net cash.

How Healthy Is China United Network Communications' Balance Sheet?

According to the last reported balance sheet, China United Network Communications had liabilities of CN¥259.4b due within 12 months, and liabilities of CN¥42.6b due beyond 12 months. Offsetting these obligations, it had cash of CN¥59.7b as well as receivables valued at CN¥59.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥182.7b.

When you consider that this deficiency exceeds the company's huge CN¥149.5b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. China United Network Communications boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Fortunately, China United Network Communications grew its EBIT by 8.6% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine China United Network Communications's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China United Network Communications 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. Happily for any shareholders, China United Network Communications actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although China United Network Communications's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥43.6b. The cherry on top was that in converted 195% of that EBIT to free cash flow, bringing in CN¥20b. So we are not troubled with China United Network Communications'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. For instance, we've identified 1 warning sign for China United Network Communications that you should be aware of.

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