The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Shenzhen TXD Technology Co.,Ltd. (SZSE:002845) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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 examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen TXD TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Shenzhen TXD TechnologyLtd had CN¥1.05b of debt in September 2023, down from CN¥1.12b, one year before. However, because it has a cash reserve of CN¥688.6m, its net debt is less, at about CN¥364.3m.

How Strong Is Shenzhen TXD TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Shenzhen TXD TechnologyLtd had liabilities of CN¥4.44b due within 12 months, and liabilities of CN¥521.0m due beyond 12 months. On the other hand, it had cash of CN¥688.6m and CN¥2.69b worth of receivables due within a year. So its liabilities total CN¥1.58b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shenzhen TXD TechnologyLtd has a market capitalization of CN¥4.57b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenzhen TXD TechnologyLtd 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 TXD TechnologyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥8.1b, which is a fall of 21%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Shenzhen TXD TechnologyLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥344m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥62m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. We've identified 1 warning sign with Shenzhen TXD TechnologyLtd , 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.