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. We note that Capinfo Company Limited (HKG:1075) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Capinfo's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Capinfo had CN¥295.8m of debt, an increase on CN¥243.3m, over one year. However, its balance sheet shows it holds CN¥773.1m in cash, so it actually has CN¥477.4m net cash.

A Look At Capinfo's Liabilities

We can see from the most recent balance sheet that Capinfo had liabilities of CN¥1.26b falling due within a year, and liabilities of CN¥32.0m due beyond that. Offsetting these obligations, it had cash of CN¥773.1m as well as receivables valued at CN¥561.5m due within 12 months. So it can boast CN¥40.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Capinfo's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Capinfo boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Capinfo'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, Capinfo saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that's not too bad, we'd prefer see growth.

So How Risky Is Capinfo?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Capinfo lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥30m of cash and made a loss of CN¥73m. With only CN¥477.4m on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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. Be aware that Capinfo is showing 2 warning signs in our investment analysis , you should know about...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com