Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Shida Shinghwa Advanced Material Group Co., Ltd. (SHSE:603026) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Shida Shinghwa Advanced Material Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shida Shinghwa Advanced Material Group had CN¥2.71b of debt, an increase on CN¥780.8m, over one year. However, it also had CN¥1.55b in cash, and so its net debt is CN¥1.16b.

How Healthy Is Shida Shinghwa Advanced Material Group's Balance Sheet?

We can see from the most recent balance sheet that Shida Shinghwa Advanced Material Group had liabilities of CN¥3.41b falling due within a year, and liabilities of CN¥1.69b due beyond that. Offsetting this, it had CN¥1.55b in cash and CN¥1.45b in receivables that were due within 12 months. So its liabilities total CN¥2.10b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Shida Shinghwa Advanced Material Group is worth CN¥6.84b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 Shida Shinghwa Advanced Material Group 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.

Over 12 months, Shida Shinghwa Advanced Material Group made a loss at the EBIT level, and saw its revenue drop to CN¥5.4b, which is a fall of 14%. We would much prefer see growth.

Caveat Emptor

Not only did Shida Shinghwa Advanced Material Group's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥127m at the EBIT level. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥1.3b of cash over the last year. So suffice it to say we consider the stock very risky. For riskier companies like Shida Shinghwa Advanced Material Group I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.