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 can see that Farasis Energy (Gan Zhou) Co., Ltd. (SHSE:688567) does use debt in its business. 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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Farasis Energy (Gan Zhou) Carry?

As you can see below, Farasis Energy (Gan Zhou) had CN¥3.63b of debt at September 2024, down from CN¥4.97b a year prior. But on the other hand it also has CN¥7.39b in cash, leading to a CN¥3.76b net cash position.

How Healthy Is Farasis Energy (Gan Zhou)'s Balance Sheet?

According to the last reported balance sheet, Farasis Energy (Gan Zhou) had liabilities of CN¥11.3b due within 12 months, and liabilities of CN¥3.71b due beyond 12 months. Offsetting these obligations, it had cash of CN¥7.39b as well as receivables valued at CN¥3.03b due within 12 months. So its liabilities total CN¥4.63b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Farasis Energy (Gan Zhou) has a market capitalization of CN¥16.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Farasis Energy (Gan Zhou) also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Farasis Energy (Gan Zhou)'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.

Over 12 months, Farasis Energy (Gan Zhou) 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.

So How Risky Is Farasis Energy (Gan Zhou)?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Farasis Energy (Gan Zhou) had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥951m of cash and made a loss of CN¥608m. While this does make the company a bit risky, it's important to remember it has net cash of CN¥3.76b. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Farasis Energy (Gan Zhou) has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.