Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Grace Fabric Technology Co.,Ltd. (SHSE:603256) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Grace Fabric TechnologyLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Grace Fabric TechnologyLtd had debt of CN¥869.7m, up from CN¥783.1m in one year. However, because it has a cash reserve of CN¥176.6m, its net debt is less, at about CN¥693.1m.

A Look At Grace Fabric TechnologyLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Grace Fabric TechnologyLtd had liabilities of CN¥856.3m due within 12 months and liabilities of CN¥263.1m due beyond that. On the other hand, it had cash of CN¥176.6m and CN¥357.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥585.5m.

Of course, Grace Fabric TechnologyLtd has a market capitalization of CN¥6.05b, 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. 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 Grace Fabric TechnologyLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Grace Fabric TechnologyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥649m, which is a fall of 2.3%. That's not what we would hope to see.

Caveat Emptor

Importantly, Grace Fabric TechnologyLtd had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥66m. 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¥340m of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Grace Fabric TechnologyLtd .

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.