The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Hundsun Technologies Inc. (SHSE:600570) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hundsun Technologies's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hundsun Technologies had CN¥718.1m of debt in June 2024, down from CN¥796.5m, one year before. But on the other hand it also has CN¥2.14b in cash, leading to a CN¥1.43b net cash position.

How Healthy Is Hundsun Technologies' Balance Sheet?

According to the last reported balance sheet, Hundsun Technologies had liabilities of CN¥4.25b due within 12 months, and liabilities of CN¥277.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.14b as well as receivables valued at CN¥1.40b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥978.7m.

Of course, Hundsun Technologies has a market capitalization of CN¥30.5b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Hundsun Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Hundsun Technologies grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. 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 Hundsun Technologies 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hundsun Technologies may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Hundsun Technologies's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Hundsun Technologies has CN¥1.43b in net cash. And we liked the look of last year's 33% year-on-year EBIT growth. So we don't think Hundsun Technologies's use of debt is risky. 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 example, we've discovered 3 warning signs for Hundsun Technologies that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.