Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Hunan Changyuan Lico Co.,Ltd. (SHSE:688779) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Hunan Changyuan LicoLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Hunan Changyuan LicoLtd had CN¥3.65b in debt in September 2023; about the same as the year before. However, it also had CN¥1.46b in cash, and so its net debt is CN¥2.19b.

How Strong Is Hunan Changyuan LicoLtd's Balance Sheet?

The latest balance sheet data shows that Hunan Changyuan LicoLtd had liabilities of CN¥3.75b due within a year, and liabilities of CN¥3.88b falling due after that. Offsetting these obligations, it had cash of CN¥1.46b as well as receivables valued at CN¥6.54b due within 12 months. So it can boast CN¥372.0m more liquid assets than total liabilities.

This surplus suggests that Hunan Changyuan LicoLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Hunan Changyuan LicoLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Hunan Changyuan LicoLtd had a loss before interest and tax, and actually shrunk its revenue by 40%, to CN¥11b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hunan Changyuan LicoLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥218m at the EBIT level. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. Still, we'd be more encouraged to study the business in depth if it already had some free cash flow. This one is a bit too risky for our liking. 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. To that end, you should be aware of the 1 warning sign we've spotted with Hunan Changyuan LicoLtd .

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.