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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that 5i5j Holding Group Co., Ltd. (SZSE:000560) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 5i5j Holding Group's Debt?

The image below, which you can click on for greater detail, shows that 5i5j Holding Group had debt of CN¥11.8b at the end of March 2024, a reduction from CN¥13.1b over a year. However, it also had CN¥3.61b in cash, and so its net debt is CN¥8.23b.

A Look At 5i5j Holding Group's Liabilities

Zooming in on the latest balance sheet data, we can see that 5i5j Holding Group had liabilities of CN¥15.9b due within 12 months and liabilities of CN¥6.56b due beyond that. Offsetting this, it had CN¥3.61b in cash and CN¥5.31b in receivables that were due within 12 months. So it has liabilities totalling CN¥13.5b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥5.30b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, 5i5j Holding Group would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine 5i5j Holding Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, 5i5j Holding Group reported revenue of CN¥12b, which is a gain of 3.1%, 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.

Caveat Emptor

Over the last twelve months 5i5j Holding Group produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥1.1b. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely since it is low on liquid assets, and made a loss of CN¥875m in the last year. So while it's not wise to assume the company will fail, we do think it's risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for 5i5j Holding Group (of which 1 is a bit unpleasant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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