The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Yonyou Network Technology Co.,Ltd. (SHSE:600588) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Yonyou Network TechnologyLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Yonyou Network TechnologyLtd had CN¥6.15b in debt in June 2024; about the same as the year before. However, it also had CN¥5.25b in cash, and so its net debt is CN¥901.0m.

How Healthy Is Yonyou Network TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yonyou Network TechnologyLtd had liabilities of CN¥10.0b due within 12 months and liabilities of CN¥2.73b due beyond that. On the other hand, it had cash of CN¥5.25b and CN¥4.04b worth of receivables due within a year. So it has liabilities totalling CN¥3.49b more than its cash and near-term receivables, combined.

Given Yonyou Network TechnologyLtd has a market capitalization of CN¥29.4b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yonyou Network TechnologyLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Yonyou Network TechnologyLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 13%, to CN¥10b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Yonyou Network TechnologyLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥861m 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¥2.2b in negative free cash flow over the last twelve months. So in short it's a really risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Yonyou Network TechnologyLtd's profit, revenue, and operating cashflow have changed over the last few years.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.