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.' 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. As with many other companies Guizhou Zhongyida Co., Ltd (SHSE:600610) makes use of debt. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, 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.

How Much Debt Does Guizhou Zhongyida Carry?

You can click the graphic below for the historical numbers, but it shows that Guizhou Zhongyida had CN¥111.2m of debt in September 2023, down from CN¥861.8m, one year before. However, it does have CN¥44.8m in cash offsetting this, leading to net debt of about CN¥66.4m.

How Healthy Is Guizhou Zhongyida's Balance Sheet?

The latest balance sheet data shows that Guizhou Zhongyida had liabilities of CN¥989.7m due within a year, and liabilities of CN¥24.5m falling due after that. Offsetting these obligations, it had cash of CN¥44.8m as well as receivables valued at CN¥86.4m due within 12 months. So its liabilities total CN¥883.0m more than the combination of its cash and short-term receivables.

Of course, Guizhou Zhongyida has a market capitalization of CN¥4.50b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Carrying virtually no net debt, Guizhou Zhongyida has a very light debt load indeed. 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 Guizhou Zhongyida will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Guizhou Zhongyida made a loss at the EBIT level, and saw its revenue drop to CN¥1.2b, which is a fall of 14%. That's not what we would hope to see.

Caveat Emptor

Not only did Guizhou Zhongyida'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¥47m. 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. However, it doesn't help that it burned through CN¥62m of cash over the last year. 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. To that end, you should be aware of the 1 warning sign we've spotted with Guizhou Zhongyida .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.