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.' 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 Zhejiang Huatong Meat Products Co., Ltd. (SZSE:002840) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhejiang Huatong Meat Products

How Much Debt Does Zhejiang Huatong Meat Products Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Zhejiang Huatong Meat Products had debt of CN¥4.25b, up from CN¥2.67b in one year. However, it does have CN¥461.8m in cash offsetting this, leading to net debt of about CN¥3.79b.

A Look At Zhejiang Huatong Meat Products' Liabilities

Zooming in on the latest balance sheet data, we can see that Zhejiang Huatong Meat Products had liabilities of CN¥2.47b due within 12 months and liabilities of CN¥2.90b due beyond that. Offsetting these obligations, it had cash of CN¥461.8m as well as receivables valued at CN¥81.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.83b.

This is a mountain of leverage relative to its market capitalization of CN¥6.89b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Zhejiang Huatong Meat Products'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.

Over 12 months, Zhejiang Huatong Meat Products made a loss at the EBIT level, and saw its revenue drop to CN¥7.4b, which is a fall of 21%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Zhejiang Huatong Meat Products'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 CN¥245m. 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. Another cause for caution is that is bled CN¥1.8b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. Be aware that Zhejiang Huatong Meat Products is showing 3 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.