Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Dongguan Chitwing Technology Co., Ltd. (SZSE:002855) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Dongguan Chitwing Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Dongguan Chitwing Technology had debt of CN¥481.5m, up from CN¥228.0m in one year. However, it does have CN¥201.5m in cash offsetting this, leading to net debt of about CN¥279.9m.

A Look At Dongguan Chitwing Technology's Liabilities

According to the last reported balance sheet, Dongguan Chitwing Technology had liabilities of CN¥833.6m due within 12 months, and liabilities of CN¥298.0m due beyond 12 months. On the other hand, it had cash of CN¥201.5m and CN¥290.1m worth of receivables due within a year. So its liabilities total CN¥640.0m more than the combination of its cash and short-term receivables.

Of course, Dongguan Chitwing Technology has a market capitalization of CN¥4.63b, so these liabilities are probably manageable. 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 you can't view debt in total isolation; since Dongguan Chitwing Technology will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Dongguan Chitwing Technology made a loss at the EBIT level, and saw its revenue drop to CN¥1.6b, which is a fall of 39%. That makes us nervous, to say the least.

Caveat Emptor

While Dongguan Chitwing Technology's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥116m 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. Another cause for caution is that is bled CN¥39m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. We've identified 1 warning sign with Dongguan Chitwing Technology , and understanding them should be part of your investment process.

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.

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