Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Huafon Microfibre (Shanghai) Co., Ltd. (SZSE:300180) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Huafon Microfibre (Shanghai)'s Net Debt?

The chart below, which you can click on for greater detail, shows that Huafon Microfibre (Shanghai) had CN¥1.93b in debt in March 2024; about the same as the year before. However, it also had CN¥254.2m in cash, and so its net debt is CN¥1.67b.

How Strong Is Huafon Microfibre (Shanghai)'s Balance Sheet?

The latest balance sheet data shows that Huafon Microfibre (Shanghai) had liabilities of CN¥2.04b due within a year, and liabilities of CN¥708.1m falling due after that. Offsetting this, it had CN¥254.2m in cash and CN¥1.07b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.42b more than its cash and near-term receivables, combined.

Huafon Microfibre (Shanghai) has a market capitalization of CN¥6.46b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Huafon Microfibre (Shanghai)'s earnings that will influence how the balance sheet holds up in the future. 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 Huafon Microfibre (Shanghai) wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to CN¥4.8b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Huafon Microfibre (Shanghai) produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥94m. 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. For example, we would not want to see a repeat of last year's loss of CN¥182m. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Huafon Microfibre (Shanghai) you should be aware of.

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.

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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.

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