Suzhou TFC Optical Communication (SZSE:300394) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Suzhou TFC Optical Communication Co., Ltd. (SZSE:300394) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Suzhou TFC Optical Communication

What Is Suzhou TFC Optical Communication's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Suzhou TFC Optical Communication had CN¥40.0m of debt, an increase on none, over one year. But it also has CN¥2.40b in cash to offset that, meaning it has CN¥2.36b net cash.

How Healthy Is Suzhou TFC Optical Communication's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Suzhou TFC Optical Communication had liabilities of CN¥493.0m due within 12 months and liabilities of CN¥29.5m due beyond that. Offsetting these obligations, it had cash of CN¥2.40b as well as receivables valued at CN¥592.4m due within 12 months. So it can boast CN¥2.47b more liquid assets than total liabilities.

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

Better yet, Suzhou TFC Optical Communication grew its EBIT by 148% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Suzhou TFC Optical Communication's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Suzhou TFC Optical Communication 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 most recent three years, Suzhou TFC Optical Communication recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Suzhou TFC Optical Communication has net cash of CN¥2.36b, as well as more liquid assets than liabilities. And we liked the look of last year's 148% year-on-year EBIT growth. So is Suzhou TFC Optical Communication's debt a risk? It doesn't seem so to us. 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. Be aware that Suzhou TFC Optical Communication is showing 3 warning signs in our investment analysis , and 1 of those doesn't sit too well with us...

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.