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. As with many other companies Shenzhen Ecobeauty Co., Ltd. (SZSE:000010) makes use of debt. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Shenzhen Ecobeauty

What Is Shenzhen Ecobeauty's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shenzhen Ecobeauty had CN¥204.5m of debt in September 2023, down from CN¥302.1m, one year before. However, because it has a cash reserve of CN¥44.9m, its net debt is less, at about CN¥159.7m.

How Strong Is Shenzhen Ecobeauty's Balance Sheet?

The latest balance sheet data shows that Shenzhen Ecobeauty had liabilities of CN¥2.70b due within a year, and liabilities of CN¥61.0m falling due after that. On the other hand, it had cash of CN¥44.9m and CN¥2.24b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥475.6m.

Since publicly traded Shenzhen Ecobeauty shares are worth a total of CN¥3.77b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen Ecobeauty 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, Shenzhen Ecobeauty made a loss at the EBIT level, and saw its revenue drop to CN¥299m, which is a fall of 76%. To be frank that doesn't bode well.

Caveat Emptor

While Shenzhen Ecobeauty's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥607m. 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¥694m into a profit. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Shenzhen Ecobeauty is showing 2 warning signs in our investment analysis , 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.