Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Guizhou Zhongyida Co., Ltd (SHSE:600610) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Guizhou Zhongyida's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guizhou Zhongyida had debt of CN¥226.8m, up from CN¥205.4m in one year. However, it does have CN¥64.8m in cash offsetting this, leading to net debt of about CN¥162.0m.

How Strong Is Guizhou Zhongyida's Balance Sheet?

We can see from the most recent balance sheet that Guizhou Zhongyida had liabilities of CN¥1.10b falling due within a year, and liabilities of CN¥9.71m due beyond that. On the other hand, it had cash of CN¥64.8m and CN¥100.4m worth of receivables due within a year. So it has liabilities totalling CN¥939.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Guizhou Zhongyida is worth CN¥3.77b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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 Guizhou Zhongyida 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 Guizhou Zhongyida had a loss before interest and tax, and actually shrunk its revenue by 14%, to CN¥1.2b. That's not what we would hope to see.

Caveat Emptor

While Guizhou Zhongyida's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥33m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥118m into a profit. So we do think this stock is quite risky. For riskier companies like Guizhou Zhongyida I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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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