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.' 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. As with many other companies Linewell Software Co., Ltd. (SHSE:603636) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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 Linewell Software's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Linewell Software had CN¥1.60b of debt, an increase on CN¥1.16b, over one year. However, it also had CN¥216.5m in cash, and so its net debt is CN¥1.38b.

How Healthy Is Linewell Software's Balance Sheet?

We can see from the most recent balance sheet that Linewell Software had liabilities of CN¥3.16b falling due within a year, and liabilities of CN¥259.6m due beyond that. On the other hand, it had cash of CN¥216.5m and CN¥2.52b worth of receivables due within a year. So its liabilities total CN¥688.1m more than the combination of its cash and short-term receivables.

Given Linewell Software has a market capitalization of CN¥6.44b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Linewell Software's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Linewell Software had a loss before interest and tax, and actually shrunk its revenue by 22%, to CN¥1.4b. To be frank that doesn't bode well.

Caveat Emptor

While Linewell Software's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥57m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥317m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Linewell Software you should be aware of.

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.