Dufu Technology Berhad (KLSE:DUFU) Has A Pretty Healthy Balance Sheet

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.' 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 note that Dufu Technology Corp. Berhad (KLSE:DUFU) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, 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 Dufu Technology Berhad

How Much Debt Does Dufu Technology Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2022 Dufu Technology Berhad had RM44.6m of debt, an increase on RM17.3m, over one year. However, it does have RM85.8m in cash offsetting this, leading to net cash of RM41.2m.

How Strong Is Dufu Technology Berhad's Balance Sheet?

We can see from the most recent balance sheet that Dufu Technology Berhad had liabilities of RM55.9m falling due within a year, and liabilities of RM37.0m due beyond that. On the other hand, it had cash of RM85.8m and RM105.6m worth of receivables due within a year. So it actually has RM98.6m more liquid assets than total liabilities.

This surplus suggests that Dufu Technology Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Dufu Technology Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Dufu Technology Berhad grew its EBIT by 9.8% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dufu Technology Berhad'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 Dufu Technology Berhad 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, Dufu Technology Berhad reported free cash flow worth 18% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dufu Technology Berhad has RM41.2m in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 9.8% in the last twelve months. So we are not troubled with Dufu Technology Berhad's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Dufu Technology Berhad has 2 warning signs (and 1 which is concerning) we think you should know about.

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.