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. We can see that Tongyu Communication Inc. (SZSE:002792) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Tongyu Communication's Debt?

As you can see below, Tongyu Communication had CN¥23.7m of debt at September 2024, down from CN¥97.1m a year prior. However, its balance sheet shows it holds CN¥1.49b in cash, so it actually has CN¥1.46b net cash.

How Strong Is Tongyu Communication's Balance Sheet?

The latest balance sheet data shows that Tongyu Communication had liabilities of CN¥721.4m due within a year, and liabilities of CN¥26.7m falling due after that. Offsetting these obligations, it had cash of CN¥1.49b as well as receivables valued at CN¥875.9m due within 12 months. So it actually has CN¥1.61b more liquid assets than total liabilities.

This excess liquidity suggests that Tongyu Communication is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Tongyu Communication has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Tongyu Communication can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Tongyu Communication wasn't profitable at an EBIT level, but managed to grow its revenue by 25%, to CN¥1.2b. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Tongyu Communication?

While Tongyu Communication lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥80m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We think its revenue growth of 25% is a good sign. There's no doubt fast top line growth can cure all manner of ills, for a stock. 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. Case in point: We've spotted 2 warning signs for Tongyu Communication you should be aware of, and 1 of them is significant.

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.