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.' 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 Konka Group Co., Ltd. (SZSE:000016) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Konka Group

How Much Debt Does Konka Group Carry?

The chart below, which you can click on for greater detail, shows that Konka Group had CN¥22.7b in debt in September 2023; about the same as the year before. On the flip side, it has CN¥6.81b in cash leading to net debt of about CN¥15.8b.

How Strong Is Konka Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Konka Group had liabilities of CN¥19.6b due within 12 months and liabilities of CN¥11.0b due beyond that. Offsetting these obligations, it had cash of CN¥6.81b as well as receivables valued at CN¥4.36b due within 12 months. So its liabilities total CN¥19.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥7.40b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Konka Group would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Konka Group'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.

In the last year Konka Group had a loss before interest and tax, and actually shrunk its revenue by 53%, to CN¥20b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Konka Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥3.1b. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. That said, it is possible that the company will turn its fortunes around. But we think that is unlikely, given it is low on liquid assets, and burned through CN¥2.5b in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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. For example, we've discovered 2 warning signs for Konka Group that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.