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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Tungkong Inc. (SZSE:002117) does carry debt. But the more important question is: how much risk is that debt creating?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Tungkong's Debt?

As you can see below, at the end of September 2024, Tungkong had CN¥15.9m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥500.1m in cash, leading to a CN¥484.2m net cash position.

A Look At Tungkong's Liabilities

The latest balance sheet data shows that Tungkong had liabilities of CN¥489.9m due within a year, and liabilities of CN¥37.7m falling due after that. Offsetting these obligations, it had cash of CN¥500.1m as well as receivables valued at CN¥343.3m due within 12 months. So it can boast CN¥315.7m more liquid assets than total liabilities.

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

It is just as well that Tungkong's load is not too heavy, because its EBIT was down 40% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tungkong can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Tungkong 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. Happily for any shareholders, Tungkong actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Tungkong has net cash of CN¥484.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥184m, being 106% of its EBIT. So we don't have any problem with Tungkong's use of debt. 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. Case in point: We've spotted 1 warning sign for Tungkong 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.