David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Shenzhen Longsys Electronics Co., Ltd. (SZSE:301308) makes use of 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shenzhen Longsys Electronics Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Shenzhen Longsys Electronics had CN¥6.36b of debt, an increase on CN¥1.41b, over one year. On the flip side, it has CN¥900.2m in cash leading to net debt of about CN¥5.46b.

A Look At Shenzhen Longsys Electronics' Liabilities

According to the last reported balance sheet, Shenzhen Longsys Electronics had liabilities of CN¥6.85b due within 12 months, and liabilities of CN¥2.34b due beyond 12 months. On the other hand, it had cash of CN¥900.2m and CN¥1.80b worth of receivables due within a year. So it has liabilities totalling CN¥6.49b more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Longsys Electronics shares are worth a total of CN¥36.8b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shenzhen Longsys Electronics 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.

In the last year Shenzhen Longsys Electronics wasn't profitable at an EBIT level, but managed to grow its revenue by 75%, to CN¥13b. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Shenzhen Longsys Electronics still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥276m 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¥3.8b in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shenzhen Longsys Electronics is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

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