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.' 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 China Zhonghua Geotechnical Engineering Group Co., Ltd. (SZSE:002542) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is China Zhonghua Geotechnical Engineering Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that China Zhonghua Geotechnical Engineering Group had CN¥2.60b of debt in September 2024, down from CN¥3.06b, one year before. However, it does have CN¥512.0m in cash offsetting this, leading to net debt of about CN¥2.09b.

How Healthy Is China Zhonghua Geotechnical Engineering Group's Balance Sheet?

We can see from the most recent balance sheet that China Zhonghua Geotechnical Engineering Group had liabilities of CN¥4.00b falling due within a year, and liabilities of CN¥1.15b due beyond that. On the other hand, it had cash of CN¥512.0m and CN¥4.36b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥280.7m.

Since publicly traded China Zhonghua Geotechnical Engineering Group shares are worth a total of CN¥8.92b, it seems unlikely that this level of liabilities would be a major 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 China Zhonghua Geotechnical Engineering Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China Zhonghua Geotechnical Engineering Group had a loss before interest and tax, and actually shrunk its revenue by 15%, to CN¥2.1b. That's not what we would hope to see.

Caveat Emptor

While China Zhonghua Geotechnical Engineering Group'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¥547m. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. For example, we would not want to see a repeat of last year's loss of CN¥631m. In the meantime, we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that China Zhonghua Geotechnical Engineering Group is showing 2 warning signs in our investment analysis , you should know about...

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.