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. We can see that Haichang Ocean Park Holdings Ltd. (HKG:2255) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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.

Check out our latest analysis for Haichang Ocean Park Holdings

How Much Debt Does Haichang Ocean Park Holdings Carry?

As you can see below, Haichang Ocean Park Holdings had CN¥5.10b of debt at December 2021, down from CN¥8.61b a year prior. However, it also had CN¥3.21b in cash, and so its net debt is CN¥1.90b.

A Look At Haichang Ocean Park Holdings' Liabilities

According to the last reported balance sheet, Haichang Ocean Park Holdings had liabilities of CN¥3.36b due within 12 months, and liabilities of CN¥4.53b due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.21b as well as receivables valued at CN¥125.0m due within 12 months. So it has liabilities totalling CN¥4.56b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Haichang Ocean Park Holdings is worth CN¥17.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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 ultimately the future profitability of the business will decide if Haichang Ocean Park Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Over 12 months, Haichang Ocean Park Holdings reported revenue of CN¥2.5b, which is a gain of 111%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

While we can certainly appreciate Haichang Ocean Park Holdings's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost CN¥96m 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. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of CN¥60m and the profit of CN¥845m. So one might argue that there's still a chance it can get things on the right track. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Haichang Ocean Park Holdings (of which 2 are significant!) you should know about.

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.

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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.