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. We can see that Guangdong Rongtai Industry Co.,Ltd (SHSE:600589) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Guangdong Rongtai IndustryLtd's Debt?

The image below, which you can click on for greater detail, shows that Guangdong Rongtai IndustryLtd had debt of CN¥268.9m at the end of June 2024, a reduction from CN¥1.37b over a year. However, it does have CN¥370.5m in cash offsetting this, leading to net cash of CN¥101.6m.

How Strong Is Guangdong Rongtai IndustryLtd's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Rongtai IndustryLtd had liabilities of CN¥321.0m falling due within a year, and liabilities of CN¥244.9m due beyond that. Offsetting this, it had CN¥370.5m in cash and CN¥150.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥45.3m.

Having regard to Guangdong Rongtai IndustryLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥3.77b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Guangdong Rongtai IndustryLtd also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Guangdong Rongtai IndustryLtd'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 Guangdong Rongtai IndustryLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 34%, to CN¥387m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Guangdong Rongtai IndustryLtd?

Although Guangdong Rongtai IndustryLtd had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of CN¥124m. 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. One positive is that Guangdong Rongtai IndustryLtd is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it's somewhat risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Guangdong Rongtai IndustryLtd is showing 3 warning signs in our investment analysis , and 1 of those is a bit concerning...

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.