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. We note that Liuzhou Iron&Steel Co., Ltd (SHSE:601003) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Liuzhou Iron&Steel Carry?

The chart below, which you can click on for greater detail, shows that Liuzhou Iron&Steel had CN¥30.5b in debt in June 2024; about the same as the year before. However, it does have CN¥5.33b in cash offsetting this, leading to net debt of about CN¥25.2b.

How Healthy Is Liuzhou Iron&Steel's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Liuzhou Iron&Steel had liabilities of CN¥25.7b due within 12 months and liabilities of CN¥19.6b due beyond that. Offsetting these obligations, it had cash of CN¥5.33b as well as receivables valued at CN¥2.34b due within 12 months. So its liabilities total CN¥37.6b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥6.87b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Liuzhou Iron&Steel would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Liuzhou Iron&Steel can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Liuzhou Iron&Steel reported revenue of CN¥80b, which is a gain of 9.3%, 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.

Caveat Emptor

Importantly, Liuzhou Iron&Steel had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥271m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through CN¥377m in the last year. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. 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 Liuzhou Iron&Steel is showing 2 warning signs 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.