The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Fujian Forecam Optics Co., Ltd. (SHSE:688010) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 Fujian Forecam Optics's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Fujian Forecam Optics had CN¥684.1m of debt, an increase on CN¥595.1m, over one year. However, it also had CN¥414.4m in cash, and so its net debt is CN¥269.7m.

A Look At Fujian Forecam Optics' Liabilities

The latest balance sheet data shows that Fujian Forecam Optics had liabilities of CN¥675.8m due within a year, and liabilities of CN¥235.7m falling due after that. Offsetting this, it had CN¥414.4m in cash and CN¥369.8m in receivables that were due within 12 months. So its liabilities total CN¥127.3m more than the combination of its cash and short-term receivables.

Of course, Fujian Forecam Optics has a market capitalization of CN¥5.26b, so these liabilities are probably manageable. 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 you can't view debt in total isolation; since Fujian Forecam Optics 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.

In the last year Fujian Forecam Optics had a loss before interest and tax, and actually shrunk its revenue by 13%, to CN¥606m. That's not what we would hope to see.

Caveat Emptor

Not only did Fujian Forecam Optics's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at CN¥75m. 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. We would feel better if it turned its trailing twelve month loss of CN¥66m into a profit. So we do think this stock is quite risky. When analysing debt levels, the balance sheet is the obvious place to start. 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 2 warning signs for Fujian Forecam Optics you should know about.

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.