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 Hainan Yedao (Group) Co.,Ltd (SHSE:600238) makes use of debt. But is this debt a concern to shareholders?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Hainan Yedao (Group)Ltd

What Is Hainan Yedao (Group)Ltd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Hainan Yedao (Group)Ltd had CN¥249.5m of debt in September 2023, down from CN¥287.5m, one year before. On the flip side, it has CN¥43.4m in cash leading to net debt of about CN¥206.1m.

A Look At Hainan Yedao (Group)Ltd's Liabilities

Zooming in on the latest balance sheet data, we can see that Hainan Yedao (Group)Ltd had liabilities of CN¥688.1m due within 12 months and liabilities of CN¥131.5m due beyond that. Offsetting this, it had CN¥43.4m in cash and CN¥191.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥584.6m.

Of course, Hainan Yedao (Group)Ltd has a market capitalization of CN¥4.51b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hainan Yedao (Group)Ltd 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.

In the last year Hainan Yedao (Group)Ltd had a loss before interest and tax, and actually shrunk its revenue by 52%, to CN¥237m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hainan Yedao (Group)Ltd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥182m. 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥82m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. To that end, you should be aware of the 2 warning signs we've spotted with Hainan Yedao (Group)Ltd .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.