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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Jiangsu ChengXing Phosph-Chemicals Co., Ltd. (SHSE:600078) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. 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 Jiangsu ChengXing Phosph-Chemicals Carry?

You can click the graphic below for the historical numbers, but it shows that Jiangsu ChengXing Phosph-Chemicals had CN¥1.56b of debt in March 2024, down from CN¥1.74b, one year before. However, because it has a cash reserve of CN¥586.1m, its net debt is less, at about CN¥974.5m.

A Look At Jiangsu ChengXing Phosph-Chemicals' Liabilities

Zooming in on the latest balance sheet data, we can see that Jiangsu ChengXing Phosph-Chemicals had liabilities of CN¥1.65b due within 12 months and liabilities of CN¥1.52b due beyond that. Offsetting these obligations, it had cash of CN¥586.1m as well as receivables valued at CN¥820.9m due within 12 months. So it has liabilities totalling CN¥1.76b more than its cash and near-term receivables, combined.

Jiangsu ChengXing Phosph-Chemicals has a market capitalization of CN¥5.41b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jiangsu ChengXing Phosph-Chemicals'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.

Over 12 months, Jiangsu ChengXing Phosph-Chemicals made a loss at the EBIT level, and saw its revenue drop to CN¥3.0b, which is a fall of 30%. That makes us nervous, to say the least.

Caveat Emptor

While Jiangsu ChengXing Phosph-Chemicals's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥19m. 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. For example, we would not want to see a repeat of last year's loss of CN¥88m. In the meantime, we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Jiangsu ChengXing Phosph-Chemicals you should know about.

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.