Is Zhejiang FORE Intelligent TechnologyLtd (SZSE:301368) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Zhejiang FORE Intelligent Technology Co.,Ltd (SZSE:301368) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Zhejiang FORE Intelligent TechnologyLtd

What Is Zhejiang FORE Intelligent TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Zhejiang FORE Intelligent TechnologyLtd had debt of CN¥30.3m, up from CN¥5.24m in one year. But on the other hand it also has CN¥177.3m in cash, leading to a CN¥147.0m net cash position.

How Healthy Is Zhejiang FORE Intelligent TechnologyLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang FORE Intelligent TechnologyLtd had liabilities of CN¥271.2m due within a year, and liabilities of CN¥5.04m falling due after that. Offsetting this, it had CN¥177.3m in cash and CN¥199.0m in receivables that were due within 12 months. So it actually has CN¥100.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Zhejiang FORE Intelligent TechnologyLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zhejiang FORE Intelligent TechnologyLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Zhejiang FORE Intelligent TechnologyLtd's load is not too heavy, because its EBIT was down 86% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Zhejiang FORE Intelligent TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang FORE Intelligent TechnologyLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Zhejiang FORE Intelligent TechnologyLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang FORE Intelligent TechnologyLtd has net cash of CN¥147.0m, as well as more liquid assets than liabilities. So while Zhejiang FORE Intelligent TechnologyLtd does not have a great balance sheet, it's certainly not too bad. 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. For example Zhejiang FORE Intelligent TechnologyLtd has 4 warning signs (and 2 which are concerning) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.