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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Shanghai Huayi Group Corporation Limited (SHSE:600623) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shanghai Huayi Group

What Is Shanghai Huayi Group's Debt?

As you can see below, at the end of June 2023, Shanghai Huayi Group had CN¥12.3b of debt, up from CN¥10.2b a year ago. Click the image for more detail. But it also has CN¥15.0b in cash to offset that, meaning it has CN¥2.67b net cash.

A Look At Shanghai Huayi Group's Liabilities

We can see from the most recent balance sheet that Shanghai Huayi Group had liabilities of CN¥23.9b falling due within a year, and liabilities of CN¥9.57b due beyond that. On the other hand, it had cash of CN¥15.0b and CN¥4.60b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥13.9b.

Given this deficit is actually higher than the company's market capitalization of CN¥12.6b, we think shareholders really should watch Shanghai Huayi Group's debt levels, like a parent watching their child ride a bike for the first time. 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. Given that Shanghai Huayi Group has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shanghai Huayi Group 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, Shanghai Huayi Group saw its revenue hold pretty steady, and it did not report positive earnings before interest and tax. While that hardly impresses, its not too bad either.

So How Risky Is Shanghai Huayi Group?

Although Shanghai Huayi Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥523m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Given the lack of transparency around future revenue (and cashflow), we're nervous about this one, until it makes its first big sales. To us, it is a high risk play. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Shanghai Huayi Group , and understanding them should be part of your investment process.

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.

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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.