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.' 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. As with many other companies Inventronics (Hangzhou), Inc. (SZSE:300582) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 Inventronics (Hangzhou) Carry?

As you can see below, Inventronics (Hangzhou) had CN¥876.8m of debt at September 2024, down from CN¥1.18b a year prior. However, it does have CN¥406.1m in cash offsetting this, leading to net debt of about CN¥470.7m.

How Strong Is Inventronics (Hangzhou)'s Balance Sheet?

According to the last reported balance sheet, Inventronics (Hangzhou) had liabilities of CN¥1.22b due within 12 months, and liabilities of CN¥665.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥406.1m as well as receivables valued at CN¥607.3m due within 12 months. So it has liabilities totalling CN¥871.8m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Inventronics (Hangzhou) is worth CN¥3.76b, 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. There's no doubt that we learn most about debt from the balance sheet. But it is Inventronics (Hangzhou)'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, Inventronics (Hangzhou) reported revenue of CN¥2.8b, which is a gain of 24%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Inventronics (Hangzhou) still had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at CN¥28m. 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. For example, we would not want to see a repeat of last year's loss of CN¥46m. So we do think this stock is quite risky. 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. We've identified 1 warning sign with Inventronics (Hangzhou) , and understanding them should be part of your investment process.

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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