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.' 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 Shandong Longda Meishi Co., Ltd. (SZSE:002726) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Shandong Longda Meishi Carry?

As you can see below, at the end of March 2024, Shandong Longda Meishi had CN¥3.04b of debt, up from CN¥2.64b a year ago. Click the image for more detail. However, it does have CN¥1.09b in cash offsetting this, leading to net debt of about CN¥1.95b.

How Strong Is Shandong Longda Meishi's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shandong Longda Meishi had liabilities of CN¥2.92b due within 12 months and liabilities of CN¥1.39b due beyond that. Offsetting this, it had CN¥1.09b in cash and CN¥471.2m in receivables that were due within 12 months. So it has liabilities totalling CN¥2.75b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Shandong Longda Meishi has a market capitalization of CN¥7.38b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 ultimately the future profitability of the business will decide if Shandong Longda Meishi can strengthen its balance sheet over time. 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, Shandong Longda Meishi made a loss at the EBIT level, and saw its revenue drop to CN¥12b, which is a fall of 24%. To be frank that doesn't bode well.

Caveat Emptor

While Shandong Longda Meishi's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable CN¥1.1b at the EBIT level. 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. Another cause for caution is that is bled CN¥926m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Shandong Longda Meishi .

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.