Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Shanghai Shenda Co., Ltd (SHSE:600626) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 Shanghai Shenda's Net Debt?

The image below, which you can click on for greater detail, shows that Shanghai Shenda had debt of CN¥2.90b at the end of March 2024, a reduction from CN¥3.31b over a year. However, it does have CN¥1.37b in cash offsetting this, leading to net debt of about CN¥1.53b.

A Look At Shanghai Shenda's Liabilities

According to the last reported balance sheet, Shanghai Shenda had liabilities of CN¥4.76b due within 12 months, and liabilities of CN¥1.87b due beyond 12 months. On the other hand, it had cash of CN¥1.37b and CN¥2.16b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.10b.

This deficit is considerable relative to its market capitalization of CN¥3.76b, so it does suggest shareholders should keep an eye on Shanghai Shenda's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 Shanghai Shenda will need earnings to service that debt. 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.

In the last year Shanghai Shenda wasn't profitable at an EBIT level, but managed to grow its revenue by 4.3%, to CN¥12b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Shanghai Shenda had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥53m 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. Another cause for caution is that is bled CN¥125m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Shanghai Shenda you should be aware of, and 1 of them makes us a bit uncomfortable.

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.