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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shanghai Metersbonwe Fashion and Accessories Co., Ltd. (SZSE:002269) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shanghai Metersbonwe Fashion and Accessories Carry?

The image below, which you can click on for greater detail, shows that Shanghai Metersbonwe Fashion and Accessories had debt of CN¥471.3m at the end of March 2024, a reduction from CN¥952.2m over a year. On the flip side, it has CN¥330.8m in cash leading to net debt of about CN¥140.5m.

How Healthy Is Shanghai Metersbonwe Fashion and Accessories' Balance Sheet?

We can see from the most recent balance sheet that Shanghai Metersbonwe Fashion and Accessories had liabilities of CN¥1.67b falling due within a year, and liabilities of CN¥294.3m due beyond that. Offsetting this, it had CN¥330.8m in cash and CN¥381.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.26b.

This deficit isn't so bad because Shanghai Metersbonwe Fashion and Accessories is worth CN¥4.17b, 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 Shanghai Metersbonwe Fashion and Accessories'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, Shanghai Metersbonwe Fashion and Accessories made a loss at the EBIT level, and saw its revenue drop to CN¥1.2b, which is a fall of 11%. That's not what we would hope to see.

Caveat Emptor

Not only did Shanghai Metersbonwe Fashion and Accessories'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¥66m. 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. Another cause for caution is that is bled CN¥386m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very 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. For instance, we've identified 1 warning sign for Shanghai Metersbonwe Fashion and Accessories that you should be aware of.

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.