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 can see that Troy Information Technology Co., Ltd. (SZSE:300366) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Troy Information Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Troy Information Technology had debt of CN¥728.4m at the end of March 2024, a reduction from CN¥871.4m over a year. However, because it has a cash reserve of CN¥237.2m, its net debt is less, at about CN¥491.2m.

A Look At Troy Information Technology's Liabilities

Zooming in on the latest balance sheet data, we can see that Troy Information Technology had liabilities of CN¥1.67b due within 12 months and liabilities of CN¥19.8m due beyond that. On the other hand, it had cash of CN¥237.2m and CN¥1.09b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥364.9m.

Of course, Troy Information Technology has a market capitalization of CN¥4.46b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Troy Information Technology can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Troy Information Technology made a loss at the EBIT level, and saw its revenue drop to CN¥1.4b, which is a fall of 29%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Troy Information Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥396m 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. However, it doesn't help that it burned through CN¥32m of cash over the last year. So to be blunt we think it is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Troy Information Technology you should know about.

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.

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