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 note that Shenzhen FRD Science & Technology Co., Ltd. (SZSE:300602) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shenzhen FRD Science & Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Shenzhen FRD Science & Technology had CN¥1.30b of debt in June 2024, down from CN¥1.96b, one year before. However, it does have CN¥1.31b in cash offsetting this, leading to net cash of CN¥8.03m.

A Look At Shenzhen FRD Science & Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen FRD Science & Technology had liabilities of CN¥2.77b due within 12 months and liabilities of CN¥767.7m due beyond that. Offsetting this, it had CN¥1.31b in cash and CN¥2.05b in receivables that were due within 12 months. So its liabilities total CN¥185.2m more than the combination of its cash and short-term receivables.

Of course, Shenzhen FRD Science & Technology has a market capitalization of CN¥8.15b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Shenzhen FRD Science & Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Shenzhen FRD Science & Technology grew its EBIT by 930% last year, which is an impressive improvement. 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 Shenzhen FRD Science & Technology 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 Shenzhen FRD Science & Technology 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 two years, Shenzhen FRD Science & Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen FRD Science & Technology has CN¥8.03m in net cash. And we liked the look of last year's 930% year-on-year EBIT growth. So we are not troubled with Shenzhen FRD Science & Technology's debt use. Over time, share prices tend to follow earnings per share, so if you're interested in Shenzhen FRD Science & Technology, you may well want to click here to check an interactive graph of its earnings per share history.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.