David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Huafu Fashion Co., Ltd. (SZSE:002042) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Huafu Fashion Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Huafu Fashion had CN¥9.17b of debt, an increase on CN¥7.99b, over one year. However, it also had CN¥4.02b in cash, and so its net debt is CN¥5.15b.

How Strong Is Huafu Fashion's Balance Sheet?

We can see from the most recent balance sheet that Huafu Fashion had liabilities of CN¥9.91b falling due within a year, and liabilities of CN¥1.13b due beyond that. Offsetting this, it had CN¥4.02b in cash and CN¥1.15b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥5.89b.

This deficit is considerable relative to its market capitalization of CN¥7.79b, so it does suggest shareholders should keep an eye on Huafu Fashion's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. 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 Huafu Fashion can strengthen its balance sheet over time. 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 Huafu Fashion had a loss before interest and tax, and actually shrunk its revenue by 2.2%, to CN¥12b. That's not what we would hope to see.

Caveat Emptor

Importantly, Huafu Fashion had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥107m. 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. However, it doesn't help that it burned through CN¥599m of cash over the last year. So in short it's a really risky stock. 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 3 warning signs for Huafu Fashion (of which 2 are a bit unpleasant!) 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.