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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Mongolian Mining Corporation (HKG:975) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

Check out our latest analysis for Mongolian Mining

What Is Mongolian Mining's Debt?

As you can see below, Mongolian Mining had US$452.6m of debt, at December 2021, which is about the same as the year before. You can click the chart for greater detail. However, it also had US$25.9m in cash, and so its net debt is US$426.7m.

How Strong Is Mongolian Mining's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Mongolian Mining had liabilities of US$335.1m due within 12 months and liabilities of US$647.4m due beyond that. On the other hand, it had cash of US$25.9m and US$50.3m worth of receivables due within a year. So its liabilities total US$906.3m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$449.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Mongolian Mining would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Mongolian Mining'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.

In the last year Mongolian Mining had a loss before interest and tax, and actually shrunk its revenue by 56%, to US$184m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Mongolian Mining's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at US$12m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of US$55m. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Mongolian Mining (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

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.