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.' 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. Importantly, Shenzhen Nanshan Power Co., Ltd. (SZSE:000037) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shenzhen Nanshan Power's Net Debt?

As you can see below, Shenzhen Nanshan Power had CN¥416.8m of debt at September 2023, down from CN¥1.14b a year prior. However, because it has a cash reserve of CN¥383.9m, its net debt is less, at about CN¥32.9m.

How Healthy Is Shenzhen Nanshan Power's Balance Sheet?

The latest balance sheet data shows that Shenzhen Nanshan Power had liabilities of CN¥420.8m due within a year, and liabilities of CN¥197.2m falling due after that. Offsetting this, it had CN¥383.9m in cash and CN¥181.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥52.2m.

This state of affairs indicates that Shenzhen Nanshan Power's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥3.66b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, Shenzhen Nanshan Power has virtually no net debt, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shenzhen Nanshan Power's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shenzhen Nanshan Power had a loss before interest and tax, and actually shrunk its revenue by 10%, to CN¥622m. We would much prefer see growth.

Caveat Emptor

Not only did Shenzhen Nanshan Power's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥106m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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¥135m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 2 warning signs we've spotted with Shenzhen Nanshan Power (including 1 which is a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.