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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Zhejiang Tony Electronic Co., Ltd (SHSE:603595) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Zhejiang Tony Electronic

What Is Zhejiang Tony Electronic's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Zhejiang Tony Electronic had debt of CN¥2.17b, up from CN¥1.31b in one year. However, because it has a cash reserve of CN¥259.6m, its net debt is less, at about CN¥1.91b.

How Strong Is Zhejiang Tony Electronic's Balance Sheet?

According to the last reported balance sheet, Zhejiang Tony Electronic had liabilities of CN¥1.62b due within 12 months, and liabilities of CN¥1.20b due beyond 12 months. Offsetting these obligations, it had cash of CN¥259.6m as well as receivables valued at CN¥889.9m due within 12 months. So its liabilities total CN¥1.68b more than the combination of its cash and short-term receivables.

Zhejiang Tony Electronic has a market capitalization of CN¥8.24b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Tony Electronic'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, Zhejiang Tony Electronic reported revenue of CN¥1.8b, which is a gain of 9.0%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Zhejiang Tony Electronic had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥38m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥1.4b of cash over the last year. So suffice it to say we consider the stock very risky. 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. Case in point: We've spotted 2 warning signs for Zhejiang Tony Electronic you should be aware of, and 1 of them can't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.