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. As with many other companies Xingyuan Environment Technology Co., Ltd. (SZSE:300266) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Xingyuan Environment Technology's Debt?

As you can see below, at the end of September 2024, Xingyuan Environment Technology had CN¥5.92b of debt, up from CN¥5.68b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥374.4m, its net debt is less, at about CN¥5.55b.

How Healthy Is Xingyuan Environment Technology's Balance Sheet?

We can see from the most recent balance sheet that Xingyuan Environment Technology had liabilities of CN¥5.81b falling due within a year, and liabilities of CN¥2.99b due beyond that. On the other hand, it had cash of CN¥374.4m and CN¥1.79b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥6.64b.

This deficit casts a shadow over the CN¥4.04b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Xingyuan Environment Technology would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Xingyuan Environment Technology 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, Xingyuan Environment Technology made a loss at the EBIT level, and saw its revenue drop to CN¥739m, which is a fall of 33%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Xingyuan Environment Technology'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¥377m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of CN¥884m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Xingyuan Environment Technology is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.