Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Huizhou China Eagle Electronic Technology Inc. (SZSE:002579) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Huizhou China Eagle Electronic Technology

What Is Huizhou China Eagle Electronic Technology's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Huizhou China Eagle Electronic Technology had debt of CN¥2.35b, up from CN¥2.19b in one year. On the flip side, it has CN¥610.3m in cash leading to net debt of about CN¥1.74b.

How Strong Is Huizhou China Eagle Electronic Technology's Balance Sheet?

According to the last reported balance sheet, Huizhou China Eagle Electronic Technology had liabilities of CN¥2.43b due within 12 months, and liabilities of CN¥1.43b due beyond 12 months. Offsetting these obligations, it had cash of CN¥610.3m as well as receivables valued at CN¥845.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.41b.

This deficit isn't so bad because Huizhou China Eagle Electronic Technology is worth CN¥5.93b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Huizhou China Eagle Electronic Technology'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.

Over 12 months, Huizhou China Eagle Electronic Technology made a loss at the EBIT level, and saw its revenue drop to CN¥2.7b, which is a fall of 14%. We would much prefer see growth.

Caveat Emptor

While Huizhou China Eagle Electronic Technology's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥174m at the EBIT level. 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¥72m of cash over the last year. So suffice it to say we do consider the stock to be risky. 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 3 warning signs with Huizhou China Eagle Electronic Technology , and understanding them should be part of your investment process.

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.