Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Asiainfo Technologies Limited (HKG:1675) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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, 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 Asiainfo Technologies

What Is Asiainfo Technologies's Net Debt?

As you can see below, Asiainfo Technologies had CN¥585.7m of debt at June 2019, down from CN¥1.79b a year prior. But on the other hand it also has CN¥1.24b in cash, leading to a CN¥655.7m net cash position.

A Look At Asiainfo Technologies's Liabilities

Zooming in on the latest balance sheet data, we can see that Asiainfo Technologies had liabilities of CN¥2.85b due within 12 months and liabilities of CN¥159.9m due beyond that. Offsetting this, it had CN¥1.24b in cash and CN¥2.32b in receivables that were due within 12 months. So it can boast CN¥558.2m more liquid assets than total liabilities.

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

In fact Asiainfo Technologies's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Asiainfo Technologies can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Asiainfo Technologies 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. Happily for any shareholders, Asiainfo Technologies actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Asiainfo Technologies has net cash of CN¥655.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 142% of that EBIT to free cash flow, bringing in CN¥348m. So we don't have any problem with Asiainfo Technologies's use of debt. 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 example, we've discovered 3 warning signs for Asiainfo Technologies that you should be aware of before investing here.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.