Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Shenzhen Deren Electronic's Net Debt?

As you can see below, Shenzhen Deren Electronic had CN¥566.7m of debt at September 2024, down from CN¥990.6m a year prior. However, it also had CN¥209.4m in cash, and so its net debt is CN¥357.3m.

How Strong Is Shenzhen Deren Electronic's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen Deren Electronic had liabilities of CN¥3.33b due within 12 months and liabilities of CN¥1.96b due beyond that. Offsetting these obligations, it had cash of CN¥209.4m as well as receivables valued at CN¥2.16b due within 12 months. So its liabilities total CN¥2.92b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shenzhen Deren Electronic has a market capitalization of CN¥4.88b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 it is Shenzhen Deren Electronic's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Shenzhen Deren Electronic had a loss before interest and tax, and actually shrunk its revenue by 33%, to CN¥4.8b. To be frank that doesn't bode well.

Caveat Emptor

While Shenzhen Deren Electronic's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥299m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any 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¥435m of cash over the last year. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shenzhen Deren Electronic you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.