Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Hangzhou Lianluo Interactive Information Technology Co.,Ltd (SZSE:002280) 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 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Hangzhou Lianluo Interactive Information TechnologyLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Hangzhou Lianluo Interactive Information TechnologyLtd had debt of CN¥3.27b at the end of September 2023, a reduction from CN¥4.02b over a year. However, it also had CN¥852.1m in cash, and so its net debt is CN¥2.42b.

A Look At Hangzhou Lianluo Interactive Information TechnologyLtd's Liabilities

We can see from the most recent balance sheet that Hangzhou Lianluo Interactive Information TechnologyLtd had liabilities of CN¥5.68b falling due within a year, and liabilities of CN¥1.87b due beyond that. On the other hand, it had cash of CN¥852.1m and CN¥1.20b worth of receivables due within a year. So it has liabilities totalling CN¥5.49b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥4.01b, we think shareholders really should watch Hangzhou Lianluo Interactive Information TechnologyLtd'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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hangzhou Lianluo Interactive Information TechnologyLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Hangzhou Lianluo Interactive Information TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 13%, to CN¥12b. That's not what we would hope to see.

Caveat Emptor

While Hangzhou Lianluo Interactive Information TechnologyLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥841m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥427m in negative free cash flow over the last year. That means it's on the risky side of things. 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. To that end, you should be aware of the 1 warning sign we've spotted with Hangzhou Lianluo Interactive Information TechnologyLtd .

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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