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 COFCO Technology & Industry Co., Ltd. (SZSE:301058) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is COFCO Technology & Industry's Debt?

The image below, which you can click on for greater detail, shows that COFCO Technology & Industry had debt of CN¥47.9m at the end of June 2024, a reduction from CN¥58.1m over a year. But on the other hand it also has CN¥1.43b in cash, leading to a CN¥1.38b net cash position.

How Strong Is COFCO Technology & Industry's Balance Sheet?

We can see from the most recent balance sheet that COFCO Technology & Industry had liabilities of CN¥1.84b falling due within a year, and liabilities of CN¥63.5m due beyond that. On the other hand, it had cash of CN¥1.43b and CN¥1.23b worth of receivables due within a year. So it actually has CN¥761.1m more liquid assets than total liabilities.

This surplus suggests that COFCO Technology & Industry is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, COFCO Technology & Industry boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, COFCO Technology & Industry grew its EBIT by 26% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine COFCO Technology & Industry's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While COFCO Technology & Industry 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, COFCO Technology & Industry generated free cash flow amounting to a very robust 90% 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 COFCO Technology & Industry has CN¥1.38b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥314m, being 90% of its EBIT. So is COFCO Technology & Industry's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for COFCO Technology & Industry that you should be aware of.

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.