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 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 Montnets Cloud Technology Group Co., Ltd. (SZSE:002123) does have debt on its balance sheet. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

How Much Debt Does Montnets Cloud Technology Group Carry?

As you can see below, Montnets Cloud Technology Group had CN¥1.27b of debt at March 2024, down from CN¥1.61b a year prior. However, it also had CN¥908.5m in cash, and so its net debt is CN¥358.8m.

How Strong Is Montnets Cloud Technology Group's Balance Sheet?

According to the last reported balance sheet, Montnets Cloud Technology Group had liabilities of CN¥1.93b due within 12 months, and liabilities of CN¥208.9m due beyond 12 months. On the other hand, it had cash of CN¥908.5m and CN¥1.64b worth of receivables due within a year. So it actually has CN¥414.7m more liquid assets than total liabilities.

This surplus suggests that Montnets Cloud Technology Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Montnets Cloud Technology 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.

In the last year Montnets Cloud Technology Group wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to CN¥5.3b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Montnets Cloud Technology Group had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥143m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd be more likely to spend time trying to understand the stock if the company made a profit. This one is a bit too risky for our liking. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Montnets Cloud Technology Group's profit, revenue, and operating cashflow have changed over the last few years.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

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