Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Shenzhen Hongtao Group Co.,Ltd. (SZSE:002325) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Shenzhen Hongtao GroupLtd

What Is Shenzhen Hongtao GroupLtd's Debt?

As you can see below, Shenzhen Hongtao GroupLtd had CN¥2.91b of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥385.5m in cash offsetting this, leading to net debt of about CN¥2.53b.

A Look At Shenzhen Hongtao GroupLtd's Liabilities

The latest balance sheet data shows that Shenzhen Hongtao GroupLtd had liabilities of CN¥5.87b due within a year, and liabilities of CN¥9.70m falling due after that. On the other hand, it had cash of CN¥385.5m and CN¥6.14b worth of receivables due within a year. So it actually has CN¥645.6m more liquid assets than total liabilities.

It's good to see that Shenzhen Hongtao GroupLtd has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shenzhen Hongtao GroupLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shenzhen Hongtao GroupLtd had a loss before interest and tax, and actually shrunk its revenue by 30%, to CN¥2.3b. That makes us nervous, to say the least.

Caveat Emptor

While Shenzhen Hongtao GroupLtd's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. To be specific the EBIT loss came in at CN¥269m. Looking on the brighter side, the business has adequate liquid assets, which give it time to grow and develop before its debt becomes a near-term issue. But a profit would do more to inspire us to research the business more closely. So it seems too risky for our taste. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Shenzhen Hongtao GroupLtd has 3 warning signs (and 1 which is a bit concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.