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. As with many other companies Tianjin Troila Information Technology Co.,Ltd. (SHSE:600225) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is Tianjin Troila Information TechnologyLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that Tianjin Troila Information TechnologyLtd had CN¥2.49b in debt in March 2024; about the same as the year before. However, because it has a cash reserve of CN¥275.4m, its net debt is less, at about CN¥2.22b.

How Strong Is Tianjin Troila Information TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Tianjin Troila Information TechnologyLtd had liabilities of CN¥3.80b falling due within a year, and liabilities of CN¥1.44b due beyond that. Offsetting this, it had CN¥275.4m in cash and CN¥713.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.25b.

This is a mountain of leverage relative to its market capitalization of CN¥4.88b. 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 you can't view debt in total isolation; since Tianjin Troila Information TechnologyLtd 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 Tianjin Troila Information TechnologyLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 17%, to CN¥1.1b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Tianjin Troila Information TechnologyLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥145m. 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. Another cause for caution is that is bled CN¥1.2b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Tianjin Troila Information TechnologyLtd is showing 1 warning sign in our investment analysis , you should know about...

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.