David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, SigmaStar Technology Ltd. (SZSE:301536) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is SigmaStar Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 SigmaStar Technology had CN¥813.7m of debt, an increase on CN¥91.7m, over one year. However, its balance sheet shows it holds CN¥1.71b in cash, so it actually has CN¥891.7m net cash.

How Healthy Is SigmaStar Technology's Balance Sheet?

According to the last reported balance sheet, SigmaStar Technology had liabilities of CN¥1.04b due within 12 months, and liabilities of CN¥441.6m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.71b as well as receivables valued at CN¥164.5m due within 12 months. So it actually has CN¥391.8m more liquid assets than total liabilities.

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

In fact SigmaStar Technology's saving grace is its low debt levels, because its EBIT has tanked 53% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is SigmaStar Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. SigmaStar Technology 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. During the last three years, SigmaStar Technology generated free cash flow amounting to a very robust 95% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case SigmaStar Technology has CN¥891.7m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 95% of that EBIT to free cash flow, bringing in CN¥299m. So we are not troubled with SigmaStar Technology's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with SigmaStar Technology , and understanding them should be part of your investment process.

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.