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.' 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. We can see that Focus Media Information Technology Co., Ltd. (SZSE:002027) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Focus Media Information Technology's Net Debt?

As you can see below, at the end of September 2024, Focus Media Information Technology had CN¥2.43b of debt, up from CN¥30.1m a year ago. Click the image for more detail. But on the other hand it also has CN¥5.11b in cash, leading to a CN¥2.68b net cash position.

How Healthy Is Focus Media Information Technology's Balance Sheet?

We can see from the most recent balance sheet that Focus Media Information Technology had liabilities of CN¥5.31b falling due within a year, and liabilities of CN¥1.17b due beyond that. Offsetting this, it had CN¥5.11b in cash and CN¥2.87b in receivables that were due within 12 months. So it can boast CN¥1.50b more liquid assets than total liabilities.

Having regard to Focus Media Information Technology's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥106.0b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Focus Media Information Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Focus Media Information Technology grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Focus Media Information Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Focus Media Information Technology 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. Happily for any shareholders, Focus Media Information Technology actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Focus Media Information Technology has net cash of CN¥2.68b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥6.7b, being 164% of its EBIT. So is Focus Media Information Technology'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. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Focus Media Information Technology .

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.