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. As with many other companies Kingenta Ecological Engineering Group Co., Ltd. (SZSE:002470) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Kingenta Ecological Engineering Group

How Much Debt Does Kingenta Ecological Engineering Group Carry?

The chart below, which you can click on for greater detail, shows that Kingenta Ecological Engineering Group had CN¥4.88b in debt in June 2023; about the same as the year before. However, it does have CN¥1.34b in cash offsetting this, leading to net debt of about CN¥3.54b.

How Strong Is Kingenta Ecological Engineering Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kingenta Ecological Engineering Group had liabilities of CN¥8.09b due within 12 months and liabilities of CN¥1.94b due beyond that. Offsetting this, it had CN¥1.34b in cash and CN¥1.72b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.97b.

Given this deficit is actually higher than the company's market capitalization of CN¥6.37b, we think shareholders really should watch Kingenta Ecological Engineering Group's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kingenta Ecological Engineering Group'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.

Over 12 months, Kingenta Ecological Engineering Group made a loss at the EBIT level, and saw its revenue drop to CN¥8.7b, which is a fall of 9.4%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Kingenta Ecological Engineering Group produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥449m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of CN¥1.2b. And until that time we think this is a 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. We've identified 1 warning sign with Kingenta Ecological Engineering Group , and understanding them should be part of your investment process.

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.