Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Fujian Highton Development Co., Ltd. (SHSE:603162) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. 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 Fujian Highton Development Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Fujian Highton Development had CN¥75.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥647.1m in cash, so it actually has CN¥572.0m net cash.

How Strong Is Fujian Highton Development's Balance Sheet?

We can see from the most recent balance sheet that Fujian Highton Development had liabilities of CN¥642.6m falling due within a year, and liabilities of CN¥903.7m due beyond that. Offsetting this, it had CN¥647.1m in cash and CN¥389.3m in receivables that were due within 12 months. So its liabilities total CN¥509.9m more than the combination of its cash and short-term receivables.

Given Fujian Highton Development has a market capitalization of CN¥9.23b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Fujian Highton Development also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Fujian Highton Development has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Fujian Highton Development'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Fujian Highton Development 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. Over the last three years, Fujian Highton Development saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

We could understand if investors are concerned about Fujian Highton Development's liabilities, but we can be reassured by the fact it has has net cash of CN¥572.0m. And we liked the look of last year's 24% year-on-year EBIT growth. So we are not troubled with Fujian Highton Development's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Fujian Highton Development (1 can't be ignored!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.