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.' 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. As with many other companies China Tangshang Holdings Limited (HKG:674) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

See our latest analysis for China Tangshang Holdings

How Much Debt Does China Tangshang Holdings Carry?

As you can see below, China Tangshang Holdings had HK$99.2m of debt at March 2022, down from HK$289.5m a year prior. But on the other hand it also has HK$213.8m in cash, leading to a HK$114.5m net cash position.

How Healthy Is China Tangshang Holdings' Balance Sheet?

We can see from the most recent balance sheet that China Tangshang Holdings had liabilities of HK$875.4m falling due within a year, and liabilities of HK$482.5m due beyond that. Offsetting this, it had HK$213.8m in cash and HK$50.1m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$1.09b.

Given this deficit is actually higher than the company's market capitalization of HK$781.5m, we think shareholders really should watch China Tangshang Holdings's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. China Tangshang Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Pleasingly, China Tangshang Holdings is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 2,484% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Tangshang Holdings's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While China Tangshang Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, China Tangshang Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While China Tangshang Holdings does have more liabilities than liquid assets, it also has net cash of HK$114.5m. And we liked the look of last year's 2,484% year-on-year EBIT growth. Despite the cash, we do find China Tangshang Holdings's conversion of EBIT to free cash flow concerning, so we're not particularly comfortable with the stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for China Tangshang Holdings (of which 1 is significant!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.