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.' 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. We can see that Shaanxi Aerospace Power Hi-Tech Co., Ltd. (SHSE:600343) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Shaanxi Aerospace Power Hi-Tech's Net Debt?

The chart below, which you can click on for greater detail, shows that Shaanxi Aerospace Power Hi-Tech had CN¥404.0m in debt in June 2024; about the same as the year before. However, because it has a cash reserve of CN¥148.6m, its net debt is less, at about CN¥255.4m.

How Strong Is Shaanxi Aerospace Power Hi-Tech's Balance Sheet?

According to the last reported balance sheet, Shaanxi Aerospace Power Hi-Tech had liabilities of CN¥1.15b due within 12 months, and liabilities of CN¥247.4m due beyond 12 months. Offsetting this, it had CN¥148.6m in cash and CN¥827.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥424.2m.

Since publicly traded Shaanxi Aerospace Power Hi-Tech shares are worth a total of CN¥5.27b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shaanxi Aerospace Power Hi-Tech'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.

Over 12 months, Shaanxi Aerospace Power Hi-Tech made a loss at the EBIT level, and saw its revenue drop to CN¥921m, which is a fall of 18%. We would much prefer see growth.

Caveat Emptor

Not only did Shaanxi Aerospace Power Hi-Tech's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥208m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥206m of cash over the last year. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Shaanxi Aerospace Power Hi-Tech (of which 2 are a bit unpleasant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.