Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that MCC Meili Cloud Computing Industry Investment Co., Ltd (SZSE:000815) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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, 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 MCC Meili Cloud Computing Industry Investment Carry?

You can click the graphic below for the historical numbers, but it shows that MCC Meili Cloud Computing Industry Investment had CN¥310.0m of debt in June 2024, down from CN¥329.6m, one year before. However, it also had CN¥134.9m in cash, and so its net debt is CN¥175.1m.

How Healthy Is MCC Meili Cloud Computing Industry Investment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that MCC Meili Cloud Computing Industry Investment had liabilities of CN¥602.3m due within 12 months and liabilities of CN¥200.5m due beyond that. On the other hand, it had cash of CN¥134.9m and CN¥345.6m worth of receivables due within a year. So it has liabilities totalling CN¥322.4m more than its cash and near-term receivables, combined.

Of course, MCC Meili Cloud Computing Industry Investment has a market capitalization of CN¥5.78b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While MCC Meili Cloud Computing Industry Investment has a quite reasonable net debt to EBITDA multiple of 1.7, its interest cover seems weak, at 0.56. The main reason for this is that it has such high depreciation and amortisation. These charges may be non-cash, so they could be excluded when it comes to paying down debt. But the accounting charges are there for a reason -- some assets are seen to be losing value. In any case, it's safe to say the company has meaningful debt. Notably, MCC Meili Cloud Computing Industry Investment made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥5.7m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is MCC Meili Cloud Computing Industry Investment'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, MCC Meili Cloud Computing Industry Investment saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Both MCC Meili Cloud Computing Industry Investment's conversion of EBIT to free cash flow and its interest cover were discouraging. But its not so bad at staying on top of its total liabilities. When we consider all the factors discussed, it seems to us that MCC Meili Cloud Computing Industry Investment is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that MCC Meili Cloud Computing Industry Investment 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.