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 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. We note that Addsino Co., Ltd. (SZSE:000547) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Addsino's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Addsino had CN¥1.24b of debt, an increase on CN¥788.9m, over one year. However, it does have CN¥1.42b in cash offsetting this, leading to net cash of CN¥182.9m.

How Strong Is Addsino's Balance Sheet?

According to the last reported balance sheet, Addsino had liabilities of CN¥4.33b due within 12 months, and liabilities of CN¥490.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.42b as well as receivables valued at CN¥3.00b due within 12 months. So it has liabilities totalling CN¥396.9m more than its cash and near-term receivables, combined.

Since publicly traded Addsino shares are worth a total of CN¥10.5b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Addsino also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Addsino'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.

Over 12 months, Addsino made a loss at the EBIT level, and saw its revenue drop to CN¥1.6b, which is a fall of 45%. That makes us nervous, to say the least.

So How Risky Is Addsino?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Addsino had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥656m and booked a CN¥2.0b accounting loss. However, it has net cash of CN¥182.9m, so it has a bit of time before it will need more capital. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. There's no doubt that we learn most about debt from the balance sheet. 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 Addsino you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.