Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Dongguan Eontec Co., Ltd. (SZSE:300328) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Dongguan Eontec's Net Debt?

The chart below, which you can click on for greater detail, shows that Dongguan Eontec had CN¥688.6m in debt in September 2024; about the same as the year before. On the flip side, it has CN¥217.7m in cash leading to net debt of about CN¥470.9m.

How Strong Is Dongguan Eontec's Balance Sheet?

The latest balance sheet data shows that Dongguan Eontec had liabilities of CN¥1.02b due within a year, and liabilities of CN¥392.5m falling due after that. Offsetting these obligations, it had cash of CN¥217.7m as well as receivables valued at CN¥526.7m due within 12 months. So it has liabilities totalling CN¥670.1m more than its cash and near-term receivables, combined.

Since publicly traded Dongguan Eontec shares are worth a total of CN¥6.48b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dongguan Eontec'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.

Over 12 months, Dongguan Eontec made a loss at the EBIT level, and saw its revenue drop to CN¥1.7b, which is a fall of 2.1%. That's not what we would hope to see.

Caveat Emptor

Importantly, Dongguan Eontec had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥82m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Surprisingly, we note that it actually reported positive free cash flow of CN¥304m and a profit of CN¥717k. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Dongguan Eontec (of which 2 make us uncomfortable!) 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.