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 note that Baoding Technology Co., Ltd. (SZSE:002552) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Baoding Technology Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Baoding Technology had debt of CN¥1.13b, up from CN¥981.3m in one year. However, it also had CN¥646.3m in cash, and so its net debt is CN¥487.5m.

How Healthy Is Baoding Technology's Balance Sheet?

According to the last reported balance sheet, Baoding Technology had liabilities of CN¥2.07b due within 12 months, and liabilities of CN¥313.4m due beyond 12 months. Offsetting these obligations, it had cash of CN¥646.3m as well as receivables valued at CN¥1.41b due within 12 months. So it has liabilities totalling CN¥328.0m more than its cash and near-term receivables, combined.

Of course, Baoding Technology has a market capitalization of CN¥5.32b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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 Baoding Technology 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 Baoding Technology wasn't profitable at an EBIT level, but managed to grow its revenue by 363%, to CN¥2.9b. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Despite the top line growth, Baoding Technology still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥53m 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. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥49m and the profit of CN¥28m. So one might argue that there's still a chance it can get things on the right track. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Baoding Technology 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.