Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Touyun Biotech Group Limited (HKG:1332) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Touyun Biotech Group

What Is Touyun Biotech Group's Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Touyun Biotech Group had debt of HK$452.7m, up from HK$431.1m in one year. On the flip side, it has HK$46.3m in cash leading to net debt of about HK$406.4m.

How Strong Is Touyun Biotech Group's Balance Sheet?

According to the last reported balance sheet, Touyun Biotech Group had liabilities of HK$336.4m due within 12 months, and liabilities of HK$212.7m due beyond 12 months. On the other hand, it had cash of HK$46.3m and HK$66.3m worth of receivables due within a year. So its liabilities total HK$436.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Touyun Biotech Group has a market capitalization of HK$1.26b, 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 it is Touyun Biotech Group's earnings that will influence how the balance sheet holds up in the future. 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 Touyun Biotech Group had a loss before interest and tax, and actually shrunk its revenue by 19%, to HK$253m. We would much prefer see growth.

Caveat Emptor

Not only did Touyun Biotech Group'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 HK$61m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$39m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Touyun Biotech Group has 2 warning signs we think you should be aware of.

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.