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 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 Anhui Hwasu Co.,Ltd. (SHSE:600935) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Anhui HwasuLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Anhui HwasuLtd had CN¥998.2m of debt, an increase on CN¥210.7m, over one year. However, because it has a cash reserve of CN¥467.8m, its net debt is less, at about CN¥530.4m.

How Healthy Is Anhui HwasuLtd's Balance Sheet?

According to the last reported balance sheet, Anhui HwasuLtd had liabilities of CN¥2.96b due within 12 months, and liabilities of CN¥1.13b due beyond 12 months. Offsetting this, it had CN¥467.8m in cash and CN¥93.4m in receivables that were due within 12 months. So its liabilities total CN¥3.53b more than the combination of its cash and short-term receivables.

Anhui HwasuLtd has a market capitalization of CN¥9.05b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Anhui HwasuLtd 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, Anhui HwasuLtd saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Over the last twelve months Anhui HwasuLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥208m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥1.2b of cash over the last year. So in short it's a really risky stock. 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. For example, we've discovered 1 warning sign for Anhui HwasuLtd that you should be aware of before investing here.

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.