Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Poly Union Chemical Holding Group Co., Ltd. (SZSE:002037) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Poly Union Chemical Holding Group's Debt?

The chart below, which you can click on for greater detail, shows that Poly Union Chemical Holding Group had CN¥6.43b in debt in June 2024; about the same as the year before. However, it also had CN¥1.35b in cash, and so its net debt is CN¥5.08b.

How Strong Is Poly Union Chemical Holding Group's Balance Sheet?

We can see from the most recent balance sheet that Poly Union Chemical Holding Group had liabilities of CN¥10.8b falling due within a year, and liabilities of CN¥3.19b due beyond that. Offsetting these obligations, it had cash of CN¥1.35b as well as receivables valued at CN¥7.40b due within 12 months. So its liabilities total CN¥5.28b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CN¥3.88b, we think shareholders really should watch Poly Union Chemical Holding Group's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Poly Union Chemical Holding Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Poly Union Chemical Holding Group made a loss at the EBIT level, and saw its revenue drop to CN¥6.0b, which is a fall of 13%. That's not what we would hope to see.

Caveat Emptor

While Poly Union Chemical Holding 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. Its EBIT loss was a whopping CN¥392m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥862m in negative free cash flow over the last year. That means it's on the risky side of things. 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. For example Poly Union Chemical Holding Group has 2 warning signs (and 1 which is a bit unpleasant) we think 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.