Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Tatwah Smartech Co.,Ltd. (SZSE:002512) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Tatwah SmartechLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Tatwah SmartechLtd had debt of CN¥731.5m, up from CN¥565.8m in one year. However, it also had CN¥179.6m in cash, and so its net debt is CN¥551.9m.

A Look At Tatwah SmartechLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Tatwah SmartechLtd had liabilities of CN¥2.16b due within 12 months and liabilities of CN¥945.7m due beyond that. On the other hand, it had cash of CN¥179.6m and CN¥696.7m worth of receivables due within a year. So its liabilities total CN¥2.23b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Tatwah SmartechLtd has a market capitalization of CN¥3.74b, 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. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Tatwah SmartechLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Tatwah SmartechLtd reported revenue of CN¥2.0b, which is a gain of 35%, 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

While we can certainly appreciate Tatwah SmartechLtd's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CN¥50m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled CN¥1.5b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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 2 warning signs with Tatwah SmartechLtd , 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.