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. As with many other companies Tianshui Huatian Technology Co., Ltd. (SZSE:002185) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Tianshui Huatian Technology

What Is Tianshui Huatian Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Tianshui Huatian Technology had CN¥9.01b of debt, an increase on CN¥6.79b, over one year. However, it also had CN¥6.06b in cash, and so its net debt is CN¥2.95b.

How Healthy Is Tianshui Huatian Technology's Balance Sheet?

We can see from the most recent balance sheet that Tianshui Huatian Technology had liabilities of CN¥7.86b falling due within a year, and liabilities of CN¥5.42b due beyond that. Offsetting this, it had CN¥6.06b in cash and CN¥2.23b in receivables that were due within 12 months. So its liabilities total CN¥4.98b more than the combination of its cash and short-term receivables.

Tianshui Huatian Technology has a market capitalization of CN¥23.8b, 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. 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 Tianshui Huatian Technology can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Tianshui Huatian Technology had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥11b. We would much prefer see growth.

Caveat Emptor

Not only did Tianshui Huatian Technology's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥741m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥1.7b in negative free cash flow over the last twelve months. 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. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Tianshui Huatian Technology you should know about.

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.