David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Qingdao Doublestar Co.,Ltd (SZSE:000599) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Qingdao DoublestarLtd Carry?

The image below, which you can click on for greater detail, shows that Qingdao DoublestarLtd had debt of CN¥4.85b at the end of September 2024, a reduction from CN¥5.18b over a year. However, it does have CN¥1.14b in cash offsetting this, leading to net debt of about CN¥3.70b.

How Healthy Is Qingdao DoublestarLtd's Balance Sheet?

We can see from the most recent balance sheet that Qingdao DoublestarLtd had liabilities of CN¥5.62b falling due within a year, and liabilities of CN¥1.76b due beyond that. Offsetting this, it had CN¥1.14b in cash and CN¥1.11b in receivables that were due within 12 months. So its liabilities total CN¥5.13b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥4.08b, we think shareholders really should watch Qingdao DoublestarLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Qingdao DoublestarLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Qingdao DoublestarLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 3.7%, to CN¥4.5b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Qingdao DoublestarLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥326m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of CN¥64m over the last twelve months. So suffice it to say we consider the stock to be 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. To that end, you should be aware of the 1 warning sign we've spotted with Qingdao DoublestarLtd .

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.