David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Financial Street Holdings Co., Ltd. (SZSE:000402) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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 step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Financial Street Holdings Carry?

As you can see below, Financial Street Holdings had CN¥72.4b of debt at March 2024, down from CN¥82.2b a year prior. However, it also had CN¥12.9b in cash, and so its net debt is CN¥59.5b.

How Healthy Is Financial Street Holdings' Balance Sheet?

The latest balance sheet data shows that Financial Street Holdings had liabilities of CN¥27.9b due within a year, and liabilities of CN¥72.8b falling due after that. On the other hand, it had cash of CN¥12.9b and CN¥7.52b worth of receivables due within a year. So it has liabilities totalling CN¥80.3b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the CN¥6.43b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Financial Street Holdings would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Financial Street Holdings's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Financial Street Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥16b, which is a fall of 15%. We would much prefer see growth.

Caveat Emptor

While Financial Street Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping CN¥892m. When you combine this with the very significant balance sheet liabilities mentioned above, we are so wary of it that we are basically at a loss for the right words. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it lost CN¥2.0b in the last year. So we think buying this stock is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Financial Street Holdings , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com