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.' 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. We can see that Sharetronic Data Technology Co., Ltd. (SZSE:300857) does use debt in its business. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Sharetronic Data Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Sharetronic Data Technology had CN¥1.51b of debt, an increase on CN¥695.6m, over one year. But it also has CN¥1.64b in cash to offset that, meaning it has CN¥122.3m net cash.

How Healthy Is Sharetronic Data Technology's Balance Sheet?

The latest balance sheet data shows that Sharetronic Data Technology had liabilities of CN¥3.19b due within a year, and liabilities of CN¥268.4m falling due after that. Offsetting these obligations, it had cash of CN¥1.64b as well as receivables valued at CN¥1.55b due within 12 months. So it has liabilities totalling CN¥274.1m more than its cash and near-term receivables, combined.

This state of affairs indicates that Sharetronic Data Technology's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥26.2b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Sharetronic Data Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Sharetronic Data Technology grew its EBIT by 233% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 Sharetronic Data Technology 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 company can only pay off debt with cold hard cash, not accounting profits. Sharetronic Data Technology 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. During the last three years, Sharetronic Data Technology burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Sharetronic Data Technology has CN¥122.3m in net cash. And we liked the look of last year's 233% year-on-year EBIT growth. So we don't have any problem with Sharetronic Data Technology'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 2 warning signs for Sharetronic Data Technology you should be aware of, and 1 of them can't be ignored.

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.