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. We note that Shenzhen Fuanna Bedding and Furnishing Co.,Ltd (SZSE:002327) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shenzhen Fuanna Bedding and FurnishingLtd Carry?

As you can see below, at the end of September 2024, Shenzhen Fuanna Bedding and FurnishingLtd had CN¥80.0m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥827.3m in cash, so it actually has CN¥747.3m net cash.

A Look At Shenzhen Fuanna Bedding and FurnishingLtd's Liabilities

The latest balance sheet data shows that Shenzhen Fuanna Bedding and FurnishingLtd had liabilities of CN¥681.1m due within a year, and liabilities of CN¥169.2m falling due after that. Offsetting these obligations, it had cash of CN¥827.3m as well as receivables valued at CN¥316.7m due within 12 months. So it actually has CN¥293.7m more liquid assets than total liabilities.

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

On the other hand, Shenzhen Fuanna Bedding and FurnishingLtd saw its EBIT drop by 2.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Fuanna Bedding and FurnishingLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen Fuanna Bedding and FurnishingLtd 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, Shenzhen Fuanna Bedding and FurnishingLtd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenzhen Fuanna Bedding and FurnishingLtd has CN¥747.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥310m, being 105% of its EBIT. So is Shenzhen Fuanna Bedding and FurnishingLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Shenzhen Fuanna Bedding and FurnishingLtd you should be aware of.

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.