Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Ronglian Group Ltd. (SZSE:002642) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Ronglian Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Ronglian Group had CN¥241.5m of debt in June 2024, down from CN¥367.8m, one year before. However, it does have CN¥320.5m in cash offsetting this, leading to net cash of CN¥79.1m.

A Look At Ronglian Group's Liabilities

According to the last reported balance sheet, Ronglian Group had liabilities of CN¥1.27b due within 12 months, and liabilities of CN¥17.4m due beyond 12 months. Offsetting this, it had CN¥320.5m in cash and CN¥899.5m in receivables that were due within 12 months. So its liabilities total CN¥72.4m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Ronglian Group's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥4.94b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Ronglian Group 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 Ronglian Group'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 Ronglian Group had a loss before interest and tax, and actually shrunk its revenue by 37%, to CN¥2.1b. To be frank that doesn't bode well.

So How Risky Is Ronglian Group?

Although Ronglian Group had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥154m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Ronglian Group's profit, revenue, and operating cashflow have changed over the last few years.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.