David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Baoding Tianwei Baobian Electric Co.,Ltd. (SHSE:600550) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Baoding Tianwei Baobian ElectricLtd Carry?

As you can see below, at the end of June 2024, Baoding Tianwei Baobian ElectricLtd had CN¥2.29b of debt, up from CN¥1.52b a year ago. Click the image for more detail. On the flip side, it has CN¥561.4m in cash leading to net debt of about CN¥1.73b.

How Healthy Is Baoding Tianwei Baobian ElectricLtd's Balance Sheet?

The latest balance sheet data shows that Baoding Tianwei Baobian ElectricLtd had liabilities of CN¥5.23b due within a year, and liabilities of CN¥917.0m falling due after that. On the other hand, it had cash of CN¥561.4m and CN¥2.30b worth of receivables due within a year. So its liabilities total CN¥3.29b more than the combination of its cash and short-term receivables.

Since publicly traded Baoding Tianwei Baobian ElectricLtd shares are worth a total of CN¥18.0b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Baoding Tianwei Baobian ElectricLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Baoding Tianwei Baobian ElectricLtd reported revenue of CN¥4.0b, which is a gain of 20%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Baoding Tianwei Baobian ElectricLtd still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥1.9m 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. 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¥143m. So we do think this stock is quite 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. We've identified 1 warning sign with Baoding Tianwei Baobian ElectricLtd , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.