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. Importantly, Shenzhen Zhenye (Group) Co.,Ltd. (SZSE:000006) does carry debt. But is this debt a concern to shareholders?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shenzhen Zhenye (Group)Ltd's Debt?

The image below, which you can click on for greater detail, shows that Shenzhen Zhenye (Group)Ltd had debt of CN¥7.41b at the end of June 2024, a reduction from CN¥9.14b over a year. However, it also had CN¥3.04b in cash, and so its net debt is CN¥4.38b.

How Strong Is Shenzhen Zhenye (Group)Ltd's Balance Sheet?

The latest balance sheet data shows that Shenzhen Zhenye (Group)Ltd had liabilities of CN¥9.77b due within a year, and liabilities of CN¥5.79b falling due after that. Offsetting these obligations, it had cash of CN¥3.04b as well as receivables valued at CN¥136.7m due within 12 months. So it has liabilities totalling CN¥12.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥5.58b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Shenzhen Zhenye (Group)Ltd would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shenzhen Zhenye (Group)Ltd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Shenzhen Zhenye (Group)Ltd reported revenue of CN¥5.5b, which is a gain of 87%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Shenzhen Zhenye (Group)Ltd still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥376m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of CN¥1.2b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Shenzhen Zhenye (Group)Ltd .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.