The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Jiangsu Dagang Co., Ltd. (SZSE:002077) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Jiangsu Dagang's Debt?

The image below, which you can click on for greater detail, shows that Jiangsu Dagang had debt of CN¥449.6m at the end of September 2023, a reduction from CN¥543.5m over a year. However, it does have CN¥196.0m in cash offsetting this, leading to net debt of about CN¥253.6m.

How Strong Is Jiangsu Dagang's Balance Sheet?

We can see from the most recent balance sheet that Jiangsu Dagang had liabilities of CN¥461.2m falling due within a year, and liabilities of CN¥303.8m due beyond that. Offsetting this, it had CN¥196.0m in cash and CN¥226.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥342.3m more than its cash and near-term receivables, combined.

Since publicly traded Jiangsu Dagang shares are worth a total of CN¥7.43b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Jiangsu Dagang 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, Jiangsu Dagang made a loss at the EBIT level, and saw its revenue drop to CN¥501m, which is a fall of 16%. We would much prefer see growth.

Caveat Emptor

Not only did Jiangsu Dagang'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¥39m. 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. However, it doesn't help that it burned through CN¥127m of cash over the last year. So to be blunt we think it is risky. For riskier companies like Jiangsu Dagang I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.