Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Hengxin Shambala Culture Co.,Ltd. (SZSE:300081) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Hengxin Shambala CultureLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Hengxin Shambala CultureLtd had CN¥112.5m of debt, an increase on CN¥107.4m, over one year. However, it does have CN¥95.0m in cash offsetting this, leading to net debt of about CN¥17.5m.

How Strong Is Hengxin Shambala CultureLtd's Balance Sheet?

We can see from the most recent balance sheet that Hengxin Shambala CultureLtd had liabilities of CN¥761.1m falling due within a year, and liabilities of CN¥28.5m due beyond that. Offsetting these obligations, it had cash of CN¥95.0m as well as receivables valued at CN¥198.4m due within 12 months. So its liabilities total CN¥496.2m more than the combination of its cash and short-term receivables.

Given Hengxin Shambala CultureLtd has a market capitalization of CN¥4.05b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. But either way, Hengxin Shambala CultureLtd 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 you can't view debt in total isolation; since Hengxin Shambala CultureLtd 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.

In the last year Hengxin Shambala CultureLtd had a loss before interest and tax, and actually shrunk its revenue by 40%, to CN¥355m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hengxin Shambala CultureLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥235m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥97m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 3 warning signs we've spotted with Hengxin Shambala CultureLtd .

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.