Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Zhejiang Wazam New Materials Co.,LTD. (SHSE:603186) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Zhejiang Wazam New MaterialsLTD Carry?

As you can see below, at the end of June 2024, Zhejiang Wazam New MaterialsLTD had CN¥2.51b of debt, up from CN¥1.98b a year ago. Click the image for more detail. However, it does have CN¥573.8m in cash offsetting this, leading to net debt of about CN¥1.94b.

How Strong Is Zhejiang Wazam New MaterialsLTD's Balance Sheet?

According to the last reported balance sheet, Zhejiang Wazam New MaterialsLTD had liabilities of CN¥3.27b due within 12 months, and liabilities of CN¥1.38b due beyond 12 months. On the other hand, it had cash of CN¥573.8m and CN¥1.92b worth of receivables due within a year. So its liabilities total CN¥2.16b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Zhejiang Wazam New MaterialsLTD is worth CN¥3.61b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Wazam New MaterialsLTD's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Zhejiang Wazam New MaterialsLTD wasn't profitable at an EBIT level, but managed to grow its revenue by 14%, to CN¥3.7b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Zhejiang Wazam New MaterialsLTD produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥79m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥327m 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. Case in point: We've spotted 2 warning signs for Zhejiang Wazam New MaterialsLTD you should be aware of, and 1 of them makes us a bit uncomfortable.

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.