The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. Importantly, Merit Interactive Co.,Ltd. (SZSE:300766) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Merit InteractiveLtd

How Much Debt Does Merit InteractiveLtd Carry?

The chart below, which you can click on for greater detail, shows that Merit InteractiveLtd had CN¥132.0m in debt in June 2023; about the same as the year before. But on the other hand it also has CN¥880.4m in cash, leading to a CN¥748.5m net cash position.

How Strong Is Merit InteractiveLtd's Balance Sheet?

According to the last reported balance sheet, Merit InteractiveLtd had liabilities of CN¥258.2m due within 12 months, and liabilities of CN¥58.8m due beyond 12 months. On the other hand, it had cash of CN¥880.4m and CN¥148.2m worth of receivables due within a year. So it actually has CN¥711.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Merit InteractiveLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Merit InteractiveLtd has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Merit InteractiveLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Merit InteractiveLtd had a loss before interest and tax, and actually shrunk its revenue by 26%, to CN¥455m. That makes us nervous, to say the least.

So How Risky Is Merit InteractiveLtd?

While Merit InteractiveLtd lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥6.2m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. Be aware that Merit InteractiveLtd is showing 3 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.