These 4 Measures Indicate That Fujian Star-net Communication (SZSE:002396) Is Using Debt Reasonably Well

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.' 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. We note that Fujian Star-net Communication Co., LTD. (SZSE:002396) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for Fujian Star-net Communication

What Is Fujian Star-net Communication's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Fujian Star-net Communication had CN¥926.3m of debt, an increase on CN¥666.9m, over one year. But on the other hand it also has CN¥4.35b in cash, leading to a CN¥3.42b net cash position.

How Strong Is Fujian Star-net Communication's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Fujian Star-net Communication had liabilities of CN¥5.98b due within 12 months and liabilities of CN¥321.3m due beyond that. On the other hand, it had cash of CN¥4.35b and CN¥2.69b worth of receivables due within a year. So it can boast CN¥737.6m more liquid assets than total liabilities.

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

It is just as well that Fujian Star-net Communication's load is not too heavy, because its EBIT was down 59% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Fujian Star-net Communication's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Fujian Star-net Communication 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. During the last three years, Fujian Star-net Communication produced sturdy free cash flow equating to 77% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Fujian Star-net Communication has CN¥3.42b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥936m, being 77% of its EBIT. So we are not troubled with Fujian Star-net Communication's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Fujian Star-net Communication you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.