Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Shenzhen Sunwin Intelligent Co., Ltd. (SZSE:300044) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Shenzhen Sunwin Intelligent's Net Debt?

As you can see below, Shenzhen Sunwin Intelligent had CN¥414.0m of debt at March 2024, down from CN¥503.9m a year prior. On the flip side, it has CN¥73.9m in cash leading to net debt of about CN¥340.2m.

A Look At Shenzhen Sunwin Intelligent's Liabilities

Zooming in on the latest balance sheet data, we can see that Shenzhen Sunwin Intelligent had liabilities of CN¥572.6m due within 12 months and liabilities of CN¥375.2m due beyond that. Offsetting these obligations, it had cash of CN¥73.9m as well as receivables valued at CN¥791.3m due within 12 months. So it has liabilities totalling CN¥82.6m more than its cash and near-term receivables, combined.

Since publicly traded Shenzhen Sunwin Intelligent shares are worth a total of CN¥3.82b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shenzhen Sunwin Intelligent 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.

In the last year Shenzhen Sunwin Intelligent wasn't profitable at an EBIT level, but managed to grow its revenue by 18%, to CN¥454m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Shenzhen Sunwin Intelligent had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥107m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥29m of cash over the last year. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Shenzhen Sunwin Intelligent (1 is potentially serious) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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