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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Hunan Mendale Hometextile Co.,Ltd (SZSE:002397) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hunan Mendale HometextileLtd

How Much Debt Does Hunan Mendale HometextileLtd Carry?

As you can see below, at the end of March 2022, Hunan Mendale HometextileLtd had CN¥669.1m of debt, up from CN¥515.4m a year ago. Click the image for more detail. On the flip side, it has CN¥335.5m in cash leading to net debt of about CN¥333.5m.

How Healthy Is Hunan Mendale HometextileLtd's Balance Sheet?

The latest balance sheet data shows that Hunan Mendale HometextileLtd had liabilities of CN¥1.79b due within a year, and liabilities of CN¥103.8m falling due after that. On the other hand, it had cash of CN¥335.5m and CN¥522.0m worth of receivables due within a year. So it has liabilities totalling CN¥1.04b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hunan Mendale HometextileLtd has a market capitalization of CN¥4.08b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hunan Mendale HometextileLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Hunan Mendale HometextileLtd reported revenue of CN¥2.5b, which is a gain of 4.8%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Hunan Mendale HometextileLtd produced an earnings before interest and tax (EBIT) loss. Indeed, it lost CN¥206m 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. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥130m of cash over the last year. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Hunan Mendale HometextileLtd (1 is significant!) that you should be aware of before investing here.

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.