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. Importantly, Phenix Optical Company Limited (SHSE:600071) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

What Is Phenix Optical's Debt?

You can click the graphic below for the historical numbers, but it shows that Phenix Optical had CN¥392.0m of debt in September 2024, down from CN¥700.7m, one year before. However, because it has a cash reserve of CN¥145.7m, its net debt is less, at about CN¥246.4m.

How Healthy Is Phenix Optical's Balance Sheet?

We can see from the most recent balance sheet that Phenix Optical had liabilities of CN¥1.15b falling due within a year, and liabilities of CN¥60.4m due beyond that. Offsetting this, it had CN¥145.7m in cash and CN¥537.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥529.0m.

Since publicly traded Phenix Optical shares are worth a total of CN¥6.74b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is Phenix Optical'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, Phenix Optical made a loss at the EBIT level, and saw its revenue drop to CN¥1.7b, which is a fall of 7.6%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Phenix Optical produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥73m. 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. For example, we would not want to see a repeat of last year's loss of CN¥70m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Phenix Optical that you should be aware of.

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.