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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Sunwave Communications Co.Ltd (SZSE:002115) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Sunwave CommunicationsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Sunwave CommunicationsLtd had debt of CN¥522.1m at the end of September 2024, a reduction from CN¥581.6m over a year. However, it does have CN¥1.01b in cash offsetting this, leading to net cash of CN¥487.0m.

How Strong Is Sunwave CommunicationsLtd's Balance Sheet?

We can see from the most recent balance sheet that Sunwave CommunicationsLtd had liabilities of CN¥1.87b falling due within a year, and liabilities of CN¥137.5m due beyond that. On the other hand, it had cash of CN¥1.01b and CN¥912.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥85.9m.

This state of affairs indicates that Sunwave CommunicationsLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥5.15b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Sunwave CommunicationsLtd boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sunwave CommunicationsLtd 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.

Over 12 months, Sunwave CommunicationsLtd made a loss at the EBIT level, and saw its revenue drop to CN¥11b, which is a fall of 14%. We would much prefer see growth.

So How Risky Is Sunwave CommunicationsLtd?

Although Sunwave CommunicationsLtd had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥297m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Sunwave CommunicationsLtd you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.