Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Transwarp Technology (Shanghai) Co.,Ltd. (SHSE:688031) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Transwarp Technology (Shanghai)Ltd's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2023 Transwarp Technology (Shanghai)Ltd had debt of CN¥87.7m, up from none in one year. But it also has CN¥1.19b in cash to offset that, meaning it has CN¥1.10b net cash.
A Look At Transwarp Technology (Shanghai)Ltd's Liabilities
We can see from the most recent balance sheet that Transwarp Technology (Shanghai)Ltd had liabilities of CN¥179.3m falling due within a year, and liabilities of CN¥44.8m due beyond that. Offsetting these obligations, it had cash of CN¥1.19b as well as receivables valued at CN¥293.2m due within 12 months. So it can boast CN¥1.26b more liquid assets than total liabilities.
This surplus suggests that Transwarp Technology (Shanghai)Ltd is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Transwarp Technology (Shanghai)Ltd has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Transwarp Technology (Shanghai)Ltd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Transwarp Technology (Shanghai)Ltd wasn't profitable at an EBIT level, but managed to grow its revenue by 44%, to CN¥538m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Transwarp Technology (Shanghai)Ltd?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Transwarp Technology (Shanghai)Ltd lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of CN¥463m and booked a CN¥270m accounting loss. However, it has net cash of CN¥1.10b, so it has a bit of time before it will need more capital. With very solid revenue growth in the last year, Transwarp Technology (Shanghai)Ltd may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Transwarp Technology (Shanghai)Ltd 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.