Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Chengdu Road & Bridge Engineering CO.,LTD (SZSE:002628) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Chengdu Road & Bridge EngineeringLTD

What Is Chengdu Road & Bridge EngineeringLTD's Debt?

The image below, which you can click on for greater detail, shows that Chengdu Road & Bridge EngineeringLTD had debt of CN¥1.96b at the end of June 2022, a reduction from CN¥2.28b over a year. However, it does have CN¥342.6m in cash offsetting this, leading to net debt of about CN¥1.62b.

How Strong Is Chengdu Road & Bridge EngineeringLTD's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chengdu Road & Bridge EngineeringLTD had liabilities of CN¥2.64b due within 12 months and liabilities of CN¥1.91b due beyond that. On the other hand, it had cash of CN¥342.6m and CN¥2.97b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.23b.

This deficit isn't so bad because Chengdu Road & Bridge EngineeringLTD is worth CN¥3.55b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Chengdu Road & Bridge EngineeringLTD's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Chengdu Road & Bridge EngineeringLTD made a loss at the EBIT level, and saw its revenue drop to CN¥1.5b, which is a fall of 29%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Chengdu Road & Bridge EngineeringLTD's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥27m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. We would feel better if it turned its trailing twelve month loss of CN¥14m into a profit. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Chengdu Road & Bridge EngineeringLTD (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.