Flowing Cloud Technology (HKG:6610) Seems To Use Debt Quite Sensibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Flowing Cloud Technology Ltd (HKG:6610) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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 Flowing Cloud Technology

How Much Debt Does Flowing Cloud Technology Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Flowing Cloud Technology had CN¥95.0m of debt, an increase on CN¥80.0m, over one year. However, it does have CN¥335.9m in cash offsetting this, leading to net cash of CN¥240.9m.

A Look At Flowing Cloud Technology's Liabilities

We can see from the most recent balance sheet that Flowing Cloud Technology had liabilities of CN¥268.1m falling due within a year, and liabilities of CN¥900.0k due beyond that. Offsetting this, it had CN¥335.9m in cash and CN¥561.8m in receivables that were due within 12 months. So it actually has CN¥628.7m more liquid assets than total liabilities.

This surplus liquidity suggests that Flowing Cloud Technology's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Flowing Cloud Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

While Flowing Cloud Technology doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Flowing Cloud Technology can strengthen its balance sheet over time. 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 Flowing Cloud Technology 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, Flowing Cloud Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Flowing Cloud Technology has net cash of CN¥240.9m, as well as more liquid assets than liabilities. So we are not troubled with Flowing Cloud Technology'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. For instance, we've identified 1 warning sign for Flowing Cloud Technology that you should be aware of.

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.