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. Importantly, Bros Eastern.,Ltd (SHSE:601339) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

What Is Bros Eastern.Ltd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Bros Eastern.Ltd had CN¥5.81b of debt, an increase on CN¥5.20b, over one year. However, it does have CN¥3.10b in cash offsetting this, leading to net debt of about CN¥2.71b.

How Strong Is Bros Eastern.Ltd's Balance Sheet?

According to the last reported balance sheet, Bros Eastern.Ltd had liabilities of CN¥5.05b due within 12 months, and liabilities of CN¥1.49b due beyond 12 months. On the other hand, it had cash of CN¥3.10b and CN¥747.0m worth of receivables due within a year. So its liabilities total CN¥2.70b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Bros Eastern.Ltd is worth CN¥8.16b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Bros Eastern.Ltd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Bros Eastern.Ltd reported revenue of CN¥7.3b, which is a gain of 12%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Bros Eastern.Ltd produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥30m at the EBIT level. 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. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥977m and the profit of CN¥500m. So one might argue that there's still a chance it can get things on the right track. 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. We've identified 3 warning signs with Bros Eastern.Ltd , and understanding them should be part of your investment process.

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.