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

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. As with many other companies Suzhou TFC Optical Communication Co., Ltd. (SZSE:300394) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Suzhou TFC Optical Communication

What Is Suzhou TFC Optical Communication's Net Debt?

As you can see below, at the end of June 2024, Suzhou TFC Optical Communication had CN¥40.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥2.37b in cash, leading to a CN¥2.33b net cash position.

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

According to the last reported balance sheet, Suzhou TFC Optical Communication had liabilities of CN¥587.1m due within 12 months, and liabilities of CN¥29.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.37b as well as receivables valued at CN¥707.0m due within 12 months. So it actually has CN¥2.46b 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. Succinctly put, Suzhou TFC Optical Communication boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that Suzhou TFC Optical Communication grew its EBIT by 189% over twelve months. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

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¥2.33b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 189% over the last year. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Suzhou TFC Optical Communication (2 are potentially serious) 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.