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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Shanghai Yanhua Smartech Group Co., Ltd. (SZSE:002178) does have debt on its balance sheet. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Shanghai Yanhua Smartech Group's Net Debt?

As you can see below, Shanghai Yanhua Smartech Group had CN¥164.8m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥284.2m in cash offsetting this, leading to net cash of CN¥119.4m.

A Look At Shanghai Yanhua Smartech Group's Liabilities

We can see from the most recent balance sheet that Shanghai Yanhua Smartech Group had liabilities of CN¥910.2m falling due within a year, and liabilities of CN¥26.6m due beyond that. Offsetting these obligations, it had cash of CN¥284.2m as well as receivables valued at CN¥698.9m due within 12 months. So it can boast CN¥46.3m more liquid assets than total liabilities.

Having regard to Shanghai Yanhua Smartech Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥3.80b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Shanghai Yanhua Smartech Group boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shanghai Yanhua Smartech 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.

Over 12 months, Shanghai Yanhua Smartech Group reported revenue of CN¥715m, which is a gain of 16%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is Shanghai Yanhua Smartech Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Shanghai Yanhua Smartech Group lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥2.3m and booked a CN¥129m accounting loss. But the saving grace is the CN¥119.4m on the balance sheet. That means it could keep spending at its current rate for more than two years. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Case in point: We've spotted 1 warning sign for Shanghai Yanhua Smartech Group you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.