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.' 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 can see that Baota Industry Co., Ltd. (SZSE:000595) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Baota Industry

What Is Baota Industry's Net Debt?

As you can see below, at the end of September 2023, Baota Industry had CN¥247.1m of debt, up from CN¥219.2m a year ago. Click the image for more detail. However, it also had CN¥81.1m in cash, and so its net debt is CN¥166.0m.

A Look At Baota Industry's Liabilities

Zooming in on the latest balance sheet data, we can see that Baota Industry had liabilities of CN¥330.4m due within 12 months and liabilities of CN¥187.5m due beyond that. Offsetting these obligations, it had cash of CN¥81.1m as well as receivables valued at CN¥250.7m due within 12 months. So it has liabilities totalling CN¥186.1m more than its cash and near-term receivables, combined.

Since publicly traded Baota Industry shares are worth a total of CN¥5.80b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Baota Industry will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Baota Industry reported revenue of CN¥261m, which is a gain of 22%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Baota Industry's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at CN¥68m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥58m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. For riskier companies like Baota Industry I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.