Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Rongji Software Co., Ltd. (SZSE:002474) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Fujian Rongji Software's Net Debt?

The chart below, which you can click on for greater detail, shows that Fujian Rongji Software had CN¥589.4m in debt in September 2024; about the same as the year before. However, it also had CN¥189.7m in cash, and so its net debt is CN¥399.7m.

How Strong Is Fujian Rongji Software's Balance Sheet?

We can see from the most recent balance sheet that Fujian Rongji Software had liabilities of CN¥998.2m falling due within a year, and liabilities of CN¥99.2m due beyond that. On the other hand, it had cash of CN¥189.7m and CN¥284.9m worth of receivables due within a year. So its liabilities total CN¥622.7m more than the combination of its cash and short-term receivables.

Since publicly traded Fujian Rongji Software shares are worth a total of CN¥4.24b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Fujian Rongji Software will need earnings to service that debt. 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.

Over 12 months, Fujian Rongji Software made a loss at the EBIT level, and saw its revenue drop to CN¥435m, which is a fall of 26%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Fujian Rongji Software's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥94m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥55m of cash over the last year. So suffice it to say we do consider the stock to be risky. 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. We've identified 1 warning sign with Fujian Rongji Software , and understanding them should be part of your investment process.

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.

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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.