Warren Buffett famously said, '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. We can see that ZHEJIANG NARADA POWER SOURCE Co. , Ltd. (SZSE:300068) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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, 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 ZHEJIANG NARADA POWER SOURCE's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 ZHEJIANG NARADA POWER SOURCE had debt of CN¥9.76b, up from CN¥6.13b in one year. However, it does have CN¥2.33b in cash offsetting this, leading to net debt of about CN¥7.44b.

A Look At ZHEJIANG NARADA POWER SOURCE's Liabilities

According to the last reported balance sheet, ZHEJIANG NARADA POWER SOURCE had liabilities of CN¥11.0b due within 12 months, and liabilities of CN¥3.50b due beyond 12 months. On the other hand, it had cash of CN¥2.33b and CN¥3.73b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.46b.

This deficit isn't so bad because ZHEJIANG NARADA POWER SOURCE is worth CN¥15.1b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ZHEJIANG NARADA POWER SOURCE's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year ZHEJIANG NARADA POWER SOURCE had a loss before interest and tax, and actually shrunk its revenue by 20%, to CN¥11b. We would much prefer see growth.

Caveat Emptor

Not only did ZHEJIANG NARADA POWER SOURCE'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¥63m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥1.1b 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. For example, we've discovered 2 warning signs for ZHEJIANG NARADA POWER SOURCE that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.