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. As with many other companies BOE Varitronix Limited (HKG:710) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is BOE Varitronix's Debt?

You can click the graphic below for the historical numbers, but it shows that BOE Varitronix had HK$606.7m of debt in June 2024, down from HK$785.3m, one year before. But on the other hand it also has HK$3.90b in cash, leading to a HK$3.30b net cash position.

A Look At BOE Varitronix's Liabilities

We can see from the most recent balance sheet that BOE Varitronix had liabilities of HK$5.75b falling due within a year, and liabilities of HK$638.5m due beyond that. On the other hand, it had cash of HK$3.90b and HK$2.83b worth of receivables due within a year. So it can boast HK$336.2m more liquid assets than total liabilities.

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

In fact BOE Varitronix's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if BOE Varitronix 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. BOE Varitronix 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 most recent three years, BOE Varitronix recorded free cash flow worth 75% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case BOE Varitronix has HK$3.30b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of HK$1.8b, being 75% of its EBIT. So we are not troubled with BOE Varitronix's debt use. We'd be motivated to research the stock further if we found out that BOE Varitronix insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.