The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Goertek Inc. (SZSE:002241) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Goertek

What Is Goertek's Net Debt?

As you can see below, at the end of September 2023, Goertek had CN¥13.6b of debt, up from CN¥12.5b a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥13.3b, its net debt is less, at about CN¥342.2m.

How Healthy Is Goertek's Balance Sheet?

According to the last reported balance sheet, Goertek had liabilities of CN¥38.8b due within 12 months, and liabilities of CN¥8.18b due beyond 12 months. Offsetting these obligations, it had cash of CN¥13.3b as well as receivables valued at CN¥17.3b due within 12 months. So its liabilities total CN¥16.4b more than the combination of its cash and short-term receivables.

Goertek has a market capitalization of CN¥62.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Carrying virtually no net debt, Goertek has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Goertek can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Goertek wasn't profitable at an EBIT level, but managed to grow its revenue by 5.1%, to CN¥105b. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Goertek had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥1.1b 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of CN¥1.2b into a profit. So we do think this stock is quite risky. 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. Be aware that Goertek is showing 1 warning sign in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.