David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Hubei Wanrun New Energy Technology Co.,Ltd. (SHSE:688275) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Hubei Wanrun New Energy TechnologyLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Hubei Wanrun New Energy TechnologyLtd had debt of CN¥7.33b, up from CN¥6.30b in one year. However, it does have CN¥3.11b in cash offsetting this, leading to net debt of about CN¥4.23b.

How Healthy Is Hubei Wanrun New Energy TechnologyLtd's Balance Sheet?

According to the last reported balance sheet, Hubei Wanrun New Energy TechnologyLtd had liabilities of CN¥6.95b due within 12 months, and liabilities of CN¥4.32b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.11b as well as receivables valued at CN¥2.33b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.84b.

The deficiency here weighs heavily on the CN¥3.65b 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, Hubei Wanrun New Energy TechnologyLtd would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hubei Wanrun New Energy TechnologyLtd 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 Hubei Wanrun New Energy TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 37%, to CN¥9.3b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hubei Wanrun New Energy TechnologyLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping CN¥871m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CN¥1.1b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Hubei Wanrun New Energy TechnologyLtd you should know about.

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.