Warren Buffett famously said, '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 Grace Fabric Technology Co.,Ltd. (SHSE:603256) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Grace Fabric TechnologyLtd

What Is Grace Fabric TechnologyLtd's Debt?

As you can see below, Grace Fabric TechnologyLtd had CN¥783.0m of debt at June 2023, down from CN¥875.9m a year prior. However, it does have CN¥221.6m in cash offsetting this, leading to net debt of about CN¥561.5m.

How Healthy Is Grace Fabric TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Grace Fabric TechnologyLtd had liabilities of CN¥815.9m falling due within a year, and liabilities of CN¥246.2m due beyond that. On the other hand, it had cash of CN¥221.6m and CN¥291.5m worth of receivables due within a year. So its liabilities total CN¥549.0m more than the combination of its cash and short-term receivables.

Given Grace Fabric TechnologyLtd has a market capitalization of CN¥7.86b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Grace Fabric TechnologyLtd 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, Grace Fabric TechnologyLtd made a loss at the EBIT level, and saw its revenue drop to CN¥561m, which is a fall of 26%. That makes us nervous, to say the least.

Caveat Emptor

While Grace Fabric TechnologyLtd'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¥31m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥263m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Grace Fabric TechnologyLtd .

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.