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 Hangzhou Huaxing Chuangye Communication Technology Co., Ltd. (SZSE:300025) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Hangzhou Huaxing Chuangye Communication Technology's Debt?

As you can see below, at the end of September 2024, Hangzhou Huaxing Chuangye Communication Technology had CN¥144.6m of debt, up from CN¥74.6m a year ago. Click the image for more detail. On the flip side, it has CN¥112.9m in cash leading to net debt of about CN¥31.8m.

How Strong Is Hangzhou Huaxing Chuangye Communication Technology's Balance Sheet?

The latest balance sheet data shows that Hangzhou Huaxing Chuangye Communication Technology had liabilities of CN¥317.6m due within a year, and liabilities of CN¥5.64m falling due after that. Offsetting these obligations, it had cash of CN¥112.9m as well as receivables valued at CN¥428.9m due within 12 months. So it actually has CN¥218.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Hangzhou Huaxing Chuangye Communication Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Carrying virtually no net debt, Hangzhou Huaxing Chuangye Communication Technology has a very light debt load indeed. There's no doubt that we learn most about debt from the balance sheet. But it is Hangzhou Huaxing Chuangye Communication Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Hangzhou Huaxing Chuangye Communication Technology made a loss at the EBIT level, and saw its revenue drop to CN¥689m, which is a fall of 4.2%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Hangzhou Huaxing Chuangye Communication Technology produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥51m at the EBIT level. On a more positive note, the company does have liquid assets, so it has a bit of time to improve its operations before the debt becomes an acute problem. But we'd want to see some positive free cashflow before spending much time on trying to understand the stock. This one is a bit too risky for our liking. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Hangzhou Huaxing Chuangye Communication Technology .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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