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.' 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. We can see that Talkweb Information System Co.,Ltd. (SZSE:002261) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Talkweb Information SystemLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Talkweb Information SystemLtd had debt of CN¥1.53b, up from CN¥564.9m in one year. However, because it has a cash reserve of CN¥827.9m, its net debt is less, at about CN¥699.2m.

How Healthy Is Talkweb Information SystemLtd's Balance Sheet?

We can see from the most recent balance sheet that Talkweb Information SystemLtd had liabilities of CN¥2.13b falling due within a year, and liabilities of CN¥489.7m due beyond that. Offsetting this, it had CN¥827.9m in cash and CN¥1.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥521.2m.

Given Talkweb Information SystemLtd has a market capitalization of CN¥12.8b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Talkweb Information SystemLtd has a rather high debt to EBITDA ratio of 23.0 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 4.0 times, suggesting it can responsibly service its obligations. One redeeming factor for Talkweb Information SystemLtd is that it turned last year's EBIT loss into a gain of CN¥14m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Talkweb Information SystemLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Talkweb Information SystemLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Talkweb Information SystemLtd's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its level of total liabilities is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Talkweb Information SystemLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. For instance, we've identified 1 warning sign for Talkweb Information SystemLtd that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com