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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Macrolink Culturaltainment Development Co., Ltd. (SZSE:000620) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 Macrolink Culturaltainment Development's Debt?

As you can see below, Macrolink Culturaltainment Development had CN¥2.10b of debt at September 2024, down from CN¥15.7b a year prior. However, it also had CN¥927.3m in cash, and so its net debt is CN¥1.17b.

How Healthy Is Macrolink Culturaltainment Development's Balance Sheet?

The latest balance sheet data shows that Macrolink Culturaltainment Development had liabilities of CN¥5.87b due within a year, and liabilities of CN¥1.72b falling due after that. On the other hand, it had cash of CN¥927.3m and CN¥584.3m worth of receivables due within a year. So it has liabilities totalling CN¥6.08b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Macrolink Culturaltainment Development is worth CN¥16.0b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. There's no doubt that we learn most about debt from the balance sheet. But it is Macrolink Culturaltainment Development'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, Macrolink Culturaltainment Development made a loss at the EBIT level, and saw its revenue drop to CN¥3.5b, which is a fall of 28%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Macrolink Culturaltainment Development'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¥687m. 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. However, it doesn't help that it burned through CN¥202m of cash over the last year. So to be blunt we think it is 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. For example - Macrolink Culturaltainment Development has 2 warning signs we think you should be aware of.

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.