Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Sino Geophysical Co., Ltd (SZSE:300191) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Sino Geophysical's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 Sino Geophysical had debt of CN¥677.4m, up from CN¥377.1m in one year. On the flip side, it has CN¥401.0m in cash leading to net debt of about CN¥276.4m.

How Healthy Is Sino Geophysical's Balance Sheet?

The latest balance sheet data shows that Sino Geophysical had liabilities of CN¥847.4m due within a year, and liabilities of CN¥670.1m falling due after that. Offsetting these obligations, it had cash of CN¥401.0m as well as receivables valued at CN¥38.5m due within 12 months. So its liabilities total CN¥1.08b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sino Geophysical has a market capitalization of CN¥5.04b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sino Geophysical's earnings that will influence how the balance sheet holds up in the future. 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.

In the last year Sino Geophysical wasn't profitable at an EBIT level, but managed to grow its revenue by 9.5%, to CN¥500m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Sino Geophysical had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost CN¥44m 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¥572m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - Sino Geophysical has 1 warning sign we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.