Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Financial Street Holdings Co., Ltd. (SZSE:000402) 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 Financial Street Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Financial Street Holdings had debt of CN¥72.7b at the end of June 2024, a reduction from CN¥76.1b over a year. However, it does have CN¥13.2b in cash offsetting this, leading to net debt of about CN¥59.5b.

A Look At Financial Street Holdings' Liabilities

According to the last reported balance sheet, Financial Street Holdings had liabilities of CN¥26.4b due within 12 months, and liabilities of CN¥73.6b due beyond 12 months. Offsetting these obligations, it had cash of CN¥13.2b as well as receivables valued at CN¥7.34b due within 12 months. So its liabilities total CN¥79.5b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥9.71b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Financial Street Holdings would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Financial Street Holdings 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.

Over 12 months, Financial Street Holdings reported revenue of CN¥17b, which is a gain of 7.0%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Financial Street Holdings produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable CN¥2.1b at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥3.2b in the last year. So we're not very excited about owning this stock. Its too risky for us. 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. To that end, you should learn about the 2 warning signs we've spotted with Financial Street Holdings (including 1 which is potentially serious) .

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.