Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that UTime Limited (NASDAQ:WTO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is UTime's Net Debt?

You can click the graphic below for the historical numbers, but it shows that UTime had CN¥56.9m of debt in March 2024, down from CN¥61.9m, one year before. However, its balance sheet shows it holds CN¥76.7m in cash, so it actually has CN¥19.7m net cash.

A Look At UTime's Liabilities

The latest balance sheet data shows that UTime had liabilities of CN¥272.8m due within a year, and liabilities of CN¥14.5m falling due after that. Offsetting this, it had CN¥76.7m in cash and CN¥30.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥179.9m more than its cash and near-term receivables, combined.

Of course, UTime has a market capitalization of CN¥3.99b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, UTime also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since UTime will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, UTime made a loss at the EBIT level, and saw its revenue drop to CN¥172m, which is a fall of 14%. That's not what we would hope to see.

So How Risky Is UTime?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that UTime had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥377m of cash and made a loss of CN¥32m. Given it only has net cash of CN¥19.7m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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 4 warning signs for UTime 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.

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