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.' 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. Importantly, China First Heavy Industries (SHSE:601106) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does China First Heavy Industries Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 China First Heavy Industries had CN¥21.0b of debt, an increase on CN¥18.9b, over one year. However, it does have CN¥2.46b in cash offsetting this, leading to net debt of about CN¥18.5b.

How Strong Is China First Heavy Industries' Balance Sheet?

We can see from the most recent balance sheet that China First Heavy Industries had liabilities of CN¥18.9b falling due within a year, and liabilities of CN¥13.6b due beyond that. Offsetting this, it had CN¥2.46b in cash and CN¥14.4b in receivables that were due within 12 months. So it has liabilities totalling CN¥15.6b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of CN¥16.1b, so it does suggest shareholders should keep an eye on China First Heavy Industries' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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 China First Heavy Industries can strengthen its balance sheet over time. 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, China First Heavy Industries made a loss at the EBIT level, and saw its revenue drop to CN¥16b, which is a fall of 33%. To be frank that doesn't bode well.

Caveat Emptor

Not only did China First Heavy Industries's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥1.9b at the EBIT level. 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥3.5m of cash over the last year. So to be blunt we think it is risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how China First Heavy Industries's profit, revenue, and operating cashflow have changed over the last few years.

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.

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