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 Shanghai Fengyuzhu Culture Technology Co., Ltd. (SHSE:603466) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Shanghai Fengyuzhu Culture Technology's Net Debt?

The image below, which you can click on for greater detail, shows that Shanghai Fengyuzhu Culture Technology had debt of CN¥511.7m at the end of September 2024, a reduction from CN¥548.9m over a year. However, its balance sheet shows it holds CN¥1.71b in cash, so it actually has CN¥1.20b net cash.

How Healthy Is Shanghai Fengyuzhu Culture Technology's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Fengyuzhu Culture Technology had liabilities of CN¥1.84b falling due within a year, and liabilities of CN¥545.6m due beyond that. Offsetting this, it had CN¥1.71b in cash and CN¥1.59b in receivables that were due within 12 months. So it can boast CN¥918.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Shanghai Fengyuzhu Culture Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Shanghai Fengyuzhu Culture Technology boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shanghai Fengyuzhu Culture Technology's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year Shanghai Fengyuzhu Culture Technology had a loss before interest and tax, and actually shrunk its revenue by 35%, to CN¥1.5b. To be frank that doesn't bode well.

So How Risky Is Shanghai Fengyuzhu Culture Technology?

Although Shanghai Fengyuzhu Culture Technology had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of CN¥17m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shanghai Fengyuzhu Culture Technology 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.