Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Suzhou TFC Optical Communication Co., Ltd. (SZSE:300394) does carry debt. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Suzhou TFC Optical Communication Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Suzhou TFC Optical Communication had debt of CN¥40.0m, up from none in one year. However, its balance sheet shows it holds CN¥2.37b in cash, so it actually has CN¥2.33b net cash.

How Strong Is Suzhou TFC Optical Communication's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Suzhou TFC Optical Communication had liabilities of CN¥587.1m due within 12 months and liabilities of CN¥29.1m due beyond that. Offsetting this, it had CN¥2.37b in cash and CN¥707.0m in receivables that were due within 12 months. So it actually has CN¥2.46b more liquid assets than total liabilities.

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

Even more impressive was the fact that Suzhou TFC Optical Communication grew its EBIT by 189% over twelve months. That boost will make it even easier to pay down debt going forward. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Suzhou TFC Optical Communication can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Suzhou TFC Optical Communication 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, Suzhou TFC Optical Communication produced sturdy free cash flow equating to 76% 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 Suzhou TFC Optical Communication has net cash of CN¥2.33b, as well as more liquid assets than liabilities. And we liked the look of last year's 189% year-on-year EBIT growth. So we don't think Suzhou TFC Optical Communication's use of debt is risky. 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 Suzhou TFC Optical Communication has 3 warning signs (and 2 which are concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.