Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Shenzhen Deren Electronic Co., Ltd. (SZSE:002055) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Shenzhen Deren Electronic Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shenzhen Deren Electronic had CN¥990.6m of debt, an increase on CN¥894.4m, over one year. On the flip side, it has CN¥683.7m in cash leading to net debt of about CN¥306.9m.

How Strong Is Shenzhen Deren Electronic's Balance Sheet?

The latest balance sheet data shows that Shenzhen Deren Electronic had liabilities of CN¥3.28b due within a year, and liabilities of CN¥1.85b falling due after that. Offsetting this, it had CN¥683.7m in cash and CN¥2.34b in receivables that were due within 12 months. So its liabilities total CN¥2.10b 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 Deren Electronic has a market capitalization of CN¥4.69b, 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 Deren Electronic 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, Shenzhen Deren Electronic made a loss at the EBIT level, and saw its revenue drop to CN¥7.2b, which is a fall of 8.1%. That's not what we would hope to see.

Caveat Emptor

Over the last twelve months Shenzhen Deren Electronic produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥141m. 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¥739m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Shenzhen Deren Electronic you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.