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. We can see that Lingyuan Iron & Steel Co., Ltd. (SHSE:600231) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lingyuan Iron & Steel

How Much Debt Does Lingyuan Iron & Steel Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Lingyuan Iron & Steel had debt of CN¥1.91b, up from CN¥1.68b in one year. But it also has CN¥2.45b in cash to offset that, meaning it has CN¥539.3m net cash.

How Healthy Is Lingyuan Iron & Steel's Balance Sheet?

According to the last reported balance sheet, Lingyuan Iron & Steel had liabilities of CN¥6.99b due within 12 months, and liabilities of CN¥1.37b due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.45b as well as receivables valued at CN¥937.8m due within 12 months. So its liabilities total CN¥4.96b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of CN¥5.68b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Lingyuan Iron & Steel also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Lingyuan Iron & Steel's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Lingyuan Iron & Steel had a loss before interest and tax, and actually shrunk its revenue by 17%, to CN¥20b. We would much prefer see growth.

So How Risky Is Lingyuan Iron & Steel?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Lingyuan Iron & Steel lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥1.2b of cash and made a loss of CN¥826m. However, it has net cash of CN¥539.3m, so it has a bit of time before it will need more capital. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. Case in point: We've spotted 1 warning sign for Lingyuan Iron & Steel 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.