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 note that Hoyuan Green Energy Co., Ltd. (SHSE:603185) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

How Much Debt Does Hoyuan Green Energy Carry?

As you can see below, at the end of September 2024, Hoyuan Green Energy had CN¥2.32b of debt, up from CN¥602.6m a year ago. Click the image for more detail. However, it does have CN¥9.95b in cash offsetting this, leading to net cash of CN¥7.63b.

A Look At Hoyuan Green Energy's Liabilities

The latest balance sheet data shows that Hoyuan Green Energy had liabilities of CN¥17.8b due within a year, and liabilities of CN¥1.33b falling due after that. Offsetting this, it had CN¥9.95b in cash and CN¥1.14b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥8.08b.

This is a mountain of leverage relative to its market capitalization of CN¥11.0b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, Hoyuan Green Energy also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hoyuan Green Energy 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 Hoyuan Green Energy had a loss before interest and tax, and actually shrunk its revenue by 46%, to CN¥7.6b. That makes us nervous, to say the least.

So How Risky Is Hoyuan Green Energy?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Hoyuan Green Energy had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥3.3b and booked a CN¥2.2b accounting loss. With only CN¥7.63b on the balance sheet, it would appear that its going to need to raise capital again soon. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hoyuan Green Energy you should be aware of.

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.