The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Tongyu Communication Inc. (SZSE:002792) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.

What Is Tongyu Communication's Debt?

As you can see below, at the end of March 2024, Tongyu Communication had CN¥63.3m of debt, up from CN¥20.0m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.53b in cash, leading to a CN¥1.47b net cash position.

A Look At Tongyu Communication's Liabilities

According to the last reported balance sheet, Tongyu Communication had liabilities of CN¥767.1m due within 12 months, and liabilities of CN¥34.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.53b as well as receivables valued at CN¥943.2m due within 12 months. So it can boast CN¥1.68b more liquid assets than total liabilities.

This surplus liquidity suggests that Tongyu Communication's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Tongyu Communication has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tongyu Communication 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.

Over 12 months, Tongyu Communication reported revenue of CN¥1.2b, which is a gain of 14%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Tongyu Communication?

Although Tongyu Communication had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥56m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. With mediocre revenue growth in the last year, we're don't find the investment opportunity particularly compelling. 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. For example Tongyu Communication has 2 warning signs (and 1 which can't be ignored) we think you should know about.

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.