Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that RongFa Nuclear Equipment Co., Ltd. (SZSE:002366) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is RongFa Nuclear Equipment's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 RongFa Nuclear Equipment had debt of CN¥1.72b, up from CN¥130.0m in one year. However, it also had CN¥1.72b in cash, and so its net debt is CN¥292.0k.

How Healthy Is RongFa Nuclear Equipment's Balance Sheet?

The latest balance sheet data shows that RongFa Nuclear Equipment had liabilities of CN¥1.09b due within a year, and liabilities of CN¥1.97b falling due after that. Offsetting this, it had CN¥1.72b in cash and CN¥1.31b in receivables that were due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that RongFa Nuclear Equipment's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥6.58b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, RongFa Nuclear Equipment has virtually no net debt, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is RongFa Nuclear Equipment's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year RongFa Nuclear Equipment wasn't profitable at an EBIT level, but managed to grow its revenue by 61%, to CN¥807m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, RongFa Nuclear Equipment still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥41m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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¥2.2b of cash over the last year. So in short it's a really risky stock. 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. Be aware that RongFa Nuclear Equipment is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.

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