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.' 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. We note that Shandong Meichen Science & Technology Co.,Ltd. (SZSE:300237) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Shandong Meichen Science & TechnologyLtd Carry?

You can click the graphic below for the historical numbers, but it shows that Shandong Meichen Science & TechnologyLtd had CN¥4.06b of debt in September 2024, down from CN¥4.92b, one year before. Net debt is about the same, since the it doesn't have much cash.

How Healthy Is Shandong Meichen Science & TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Shandong Meichen Science & TechnologyLtd had liabilities of CN¥6.63b falling due within a year, and liabilities of CN¥1.11b due beyond that. On the other hand, it had cash of CN¥80.5m and CN¥5.97b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.70b.

While this might seem like a lot, it is not so bad since Shandong Meichen Science & TechnologyLtd has a market capitalization of CN¥4.22b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shandong Meichen Science & TechnologyLtd'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 Shandong Meichen Science & TechnologyLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 24%, to CN¥1.7b. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Shandong Meichen Science & TechnologyLtd's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable CN¥679m 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. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥18m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Shandong Meichen Science & TechnologyLtd that you should be aware of before investing here.

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.