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. As with many other companies Focused Photonics (Hangzhou), Inc. (SZSE:300203) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Focused Photonics (Hangzhou) Carry?

The image below, which you can click on for greater detail, shows that Focused Photonics (Hangzhou) had debt of CN¥3.67b at the end of March 2024, a reduction from CN¥3.92b over a year. However, it also had CN¥1.09b in cash, and so its net debt is CN¥2.57b.

How Healthy Is Focused Photonics (Hangzhou)'s Balance Sheet?

The latest balance sheet data shows that Focused Photonics (Hangzhou) had liabilities of CN¥3.73b due within a year, and liabilities of CN¥2.68b falling due after that. On the other hand, it had cash of CN¥1.09b and CN¥1.25b worth of receivables due within a year. So its liabilities total CN¥4.05b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥4.95b, so it does suggest shareholders should keep an eye on Focused Photonics (Hangzhou)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Focused Photonics (Hangzhou) 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 Focused Photonics (Hangzhou) had a loss before interest and tax, and actually shrunk its revenue by 7.7%, to CN¥3.2b. That's not what we would hope to see.

Caveat Emptor

Importantly, Focused Photonics (Hangzhou) had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥243m at the EBIT level. 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¥261m. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Focused Photonics (Hangzhou) has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.