Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 FAR International Holdings Group Company Limited (HKG:2516) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

How Much Debt Does FAR International Holdings Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 FAR International Holdings Group had CN¥519.7m of debt, an increase on CN¥54.4m, over one year. But on the other hand it also has CN¥587.2m in cash, leading to a CN¥67.5m net cash position.

A Look At FAR International Holdings Group's Liabilities

The latest balance sheet data shows that FAR International Holdings Group had liabilities of CN¥698.9m due within a year, and liabilities of CN¥3.04m falling due after that. On the other hand, it had cash of CN¥587.2m and CN¥620.5m worth of receivables due within a year. So it can boast CN¥505.7m more liquid assets than total liabilities.

This surplus strongly suggests that FAR International Holdings Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, FAR International Holdings Group boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, FAR International Holdings Group grew its EBIT by 203% 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 it is FAR International Holdings Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While FAR International Holdings Group 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. Over the last three years, FAR International Holdings Group saw substantial negative free cash flow, in total. 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 investigate a company's debt, in this case FAR International Holdings Group has CN¥67.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 203% over the last year. So we don't think FAR International Holdings Group'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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for FAR International Holdings Group you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.