Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Xiamen Changelight Co., Ltd. (SZSE:300102) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for Xiamen Changelight
How Much Debt Does Xiamen Changelight Carry?
The image below, which you can click on for greater detail, shows that at September 2023 Xiamen Changelight had debt of CN¥1.32b, up from CN¥1.06b in one year. However, it does have CN¥1.06b in cash offsetting this, leading to net debt of about CN¥263.8m.
A Look At Xiamen Changelight's Liabilities
According to the last reported balance sheet, Xiamen Changelight had liabilities of CN¥1.41b due within 12 months, and liabilities of CN¥942.7m due beyond 12 months. Offsetting this, it had CN¥1.06b in cash and CN¥1.18b in receivables that were due within 12 months. So it has liabilities totalling CN¥113.0m more than its cash and near-term receivables, combined.
Having regard to Xiamen Changelight's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥6.81b company is struggling for cash, we still think it's worth monitoring its balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Xiamen Changelight will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Over 12 months, Xiamen Changelight reported revenue of CN¥2.3b, which is a gain of 42%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Caveat Emptor
While we can certainly appreciate Xiamen Changelight's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at CN¥159m. 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. We would feel better if it turned its trailing twelve month loss of CN¥116m into a profit. So we do think this stock is quite risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Xiamen Changelight has 1 warning sign we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.