Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Fujian Tendering Co., Ltd. (SZSE:301136) does use debt in its business. 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Fujian Tendering's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Fujian Tendering had CN¥79.4m of debt, an increase on CN¥58.6m, over one year. However, its balance sheet shows it holds CN¥1.25b in cash, so it actually has CN¥1.17b net cash.

A Look At Fujian Tendering's Liabilities

We can see from the most recent balance sheet that Fujian Tendering had liabilities of CN¥523.6m falling due within a year, and liabilities of CN¥42.1m due beyond that. Offsetting this, it had CN¥1.25b in cash and CN¥540.2m in receivables that were due within 12 months. So it can boast CN¥1.22b more liquid assets than total liabilities.

This excess liquidity is a great indication that Fujian Tendering's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Fujian Tendering has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Fujian Tendering's load is not too heavy, because its EBIT was down 92% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujian Tendering 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 Fujian Tendering 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, Fujian Tendering produced sturdy free cash flow equating to 59% 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 it is always sensible to investigate a company's debt, in this case Fujian Tendering has CN¥1.17b in net cash and a decent-looking balance sheet. So we are not troubled with Fujian Tendering's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Fujian Tendering has 4 warning signs (and 2 which don't sit too well with us) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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