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. We note that North Huajin Chemical Industries Co.,Ltd (SZSE:000059) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is North Huajin Chemical IndustriesLtd's Debt?

As you can see below, North Huajin Chemical IndustriesLtd had CN¥10.1b of debt at September 2024, down from CN¥11.1b a year prior. However, because it has a cash reserve of CN¥4.90b, its net debt is less, at about CN¥5.22b.

How Healthy Is North Huajin Chemical IndustriesLtd's Balance Sheet?

We can see from the most recent balance sheet that North Huajin Chemical IndustriesLtd had liabilities of CN¥6.10b falling due within a year, and liabilities of CN¥8.10b due beyond that. Offsetting these obligations, it had cash of CN¥4.90b as well as receivables valued at CN¥212.9m due within 12 months. So its liabilities total CN¥9.09b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CN¥8.01b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine North Huajin Chemical IndustriesLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, North Huajin Chemical IndustriesLtd made a loss at the EBIT level, and saw its revenue drop to CN¥38b, which is a fall of 19%. That's not what we would hope to see.

Caveat Emptor

Not only did North Huajin Chemical IndustriesLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥1.1b. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥359m in negative free cash flow over the last year. That means it's on the risky side of things. 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 1 warning sign for North Huajin Chemical IndustriesLtd you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.