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.' 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 Shenzhen TXD Technology Co.,Ltd. (SZSE:002845) makes use of debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shenzhen TXD TechnologyLtd

What Is Shenzhen TXD TechnologyLtd's Debt?

The image below, which you can click on for greater detail, shows that Shenzhen TXD TechnologyLtd had debt of CN¥1.05b at the end of September 2023, a reduction from CN¥1.12b over a year. However, it also had CN¥688.6m in cash, and so its net debt is CN¥364.3m.

A Look At Shenzhen TXD TechnologyLtd's Liabilities

The latest balance sheet data shows that Shenzhen TXD TechnologyLtd had liabilities of CN¥4.44b due within a year, and liabilities of CN¥521.0m falling due after that. Offsetting this, it had CN¥688.6m in cash and CN¥2.69b in receivables that were due within 12 months. So its liabilities total CN¥1.58b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shenzhen TXD TechnologyLtd has a market capitalization of CN¥6.33b, and so it could probably strengthen its balance sheet by raising capital if it needed to. 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 you can't view debt in total isolation; since Shenzhen TXD TechnologyLtd 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.

In the last year Shenzhen TXD TechnologyLtd had a loss before interest and tax, and actually shrunk its revenue by 21%, to CN¥8.1b. That makes us nervous, to say the least.

Caveat Emptor

Not only did Shenzhen TXD TechnologyLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥344m 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¥62m 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 instance, we've identified 1 warning sign for Shenzhen TXD TechnologyLtd that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.