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 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, Chengxin Lithium Group Co., Ltd. (SZSE:002240) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Chengxin Lithium Group's Net Debt?

As you can see below, at the end of June 2024, Chengxin Lithium Group had CN¥7.23b of debt, up from CN¥5.54b a year ago. Click the image for more detail. On the flip side, it has CN¥2.63b in cash leading to net debt of about CN¥4.61b.

A Look At Chengxin Lithium Group's Liabilities

We can see from the most recent balance sheet that Chengxin Lithium Group had liabilities of CN¥7.12b falling due within a year, and liabilities of CN¥2.00b due beyond that. Offsetting these obligations, it had cash of CN¥2.63b as well as receivables valued at CN¥966.8m due within 12 months. So its liabilities total CN¥5.53b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chengxin Lithium Group has a market capitalization of CN¥9.98b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 Chengxin Lithium Group 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.

In the last year Chengxin Lithium Group had a loss before interest and tax, and actually shrunk its revenue by 51%, to CN¥5.8b. To be frank that doesn't bode well.

Caveat Emptor

While Chengxin Lithium Group's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥661m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much 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¥2.8b 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. We've identified 1 warning sign with Chengxin Lithium Group , and understanding them should be part of your investment process.

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.