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.' 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. We note that Zotye Automobile Co., Ltd (SZSE:000980) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zotye Automobile's Debt?

The chart below, which you can click on for greater detail, shows that Zotye Automobile had CN¥2.93b in debt in March 2024; about the same as the year before. However, it also had CN¥747.1m in cash, and so its net debt is CN¥2.18b.

How Strong Is Zotye Automobile's Balance Sheet?

According to the last reported balance sheet, Zotye Automobile had liabilities of CN¥3.24b due within 12 months, and liabilities of CN¥1.46b due beyond 12 months. Offsetting these obligations, it had cash of CN¥747.1m as well as receivables valued at CN¥1.51b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.45b.

While this might seem like a lot, it is not so bad since Zotye Automobile has a market capitalization of CN¥10.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Zotye Automobile 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.

Over 12 months, Zotye Automobile made a loss at the EBIT level, and saw its revenue drop to CN¥684m, which is a fall of 17%. That's not what we would hope to see.

Caveat Emptor

Not only did Zotye Automobile'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¥447m. 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¥169m of cash over the last year. So to be blunt we think it is risky. For riskier companies like Zotye Automobile 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.

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.