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 note that Daan Gene Co., Ltd. (SZSE:002030) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

What Is Daan Gene's Net Debt?

As you can see below, Daan Gene had CN¥111.7m of debt at June 2024, down from CN¥323.8m a year prior. But it also has CN¥2.64b in cash to offset that, meaning it has CN¥2.53b net cash.

How Strong Is Daan Gene's Balance Sheet?

We can see from the most recent balance sheet that Daan Gene had liabilities of CN¥1.26b falling due within a year, and liabilities of CN¥143.4m due beyond that. Offsetting this, it had CN¥2.64b in cash and CN¥2.02b in receivables that were due within 12 months. So it actually has CN¥3.26b more liquid assets than total liabilities.

This excess liquidity is a great indication that Daan Gene's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Daan Gene has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Daan Gene will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Daan Gene made a loss at the EBIT level, and saw its revenue drop to CN¥1.0b, which is a fall of 82%. That makes us nervous, to say the least.

So How Risky Is Daan Gene?

Although Daan Gene had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥456m. 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. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre 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 Daan Gene's profit, revenue, and operating cashflow have changed over the last few years.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.