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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Shenzhen Silver Basis Technology Co., Ltd. (SZSE:002786) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shenzhen Silver Basis Technology's Net Debt?

As you can see below, Shenzhen Silver Basis Technology had CN¥890.9m of debt at September 2023, down from CN¥1.49b a year prior. On the flip side, it has CN¥95.8m in cash leading to net debt of about CN¥795.1m.

How Strong Is Shenzhen Silver Basis Technology's Balance Sheet?

According to the last reported balance sheet, Shenzhen Silver Basis Technology had liabilities of CN¥3.21b due within 12 months, and liabilities of CN¥408.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥95.8m as well as receivables valued at CN¥737.6m due within 12 months. So its liabilities total CN¥2.78b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shenzhen Silver Basis Technology has a market capitalization of CN¥7.17b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shenzhen Silver Basis Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shenzhen Silver Basis Technology had a loss before interest and tax, and actually shrunk its revenue by 13%, to CN¥2.4b. We would much prefer see growth.

Caveat Emptor

While Shenzhen Silver Basis Technology's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥194m. 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. We would feel better if it turned its trailing twelve month loss of CN¥283m into a profit. So to be blunt we do think it is risky. 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. We've identified 2 warning signs with Shenzhen Silver Basis Technology , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.