Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Kingsignal Technology Co., Ltd. (SZSE:300252) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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 Kingsignal Technology's Debt?

As you can see below, Kingsignal Technology had CN¥1.33b of debt at June 2024, down from CN¥1.58b a year prior. However, it does have CN¥685.4m in cash offsetting this, leading to net debt of about CN¥641.1m.

A Look At Kingsignal Technology's Liabilities

According to the last reported balance sheet, Kingsignal Technology had liabilities of CN¥2.56b due within 12 months, and liabilities of CN¥123.9m due beyond 12 months. On the other hand, it had cash of CN¥685.4m and CN¥1.35b worth of receivables due within a year. So its liabilities total CN¥649.8m more than the combination of its cash and short-term receivables.

Of course, Kingsignal Technology has a market capitalization of CN¥4.46b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Kingsignal Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Kingsignal Technology had a loss before interest and tax, and actually shrunk its revenue by 9.7%, to CN¥1.9b. We would much prefer see growth.

Caveat Emptor

Importantly, Kingsignal Technology had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥244m 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥291m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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 instance, we've identified 2 warning signs for Kingsignal Technology that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.