David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Focused Photonics (Hangzhou), Inc. (SZSE:300203) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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, 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Focused Photonics (Hangzhou)

What Is Focused Photonics (Hangzhou)'s Debt?

As you can see below, Focused Photonics (Hangzhou) had CN¥3.88b of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have CN¥988.6m in cash offsetting this, leading to net debt of about CN¥2.89b.

How Strong Is Focused Photonics (Hangzhou)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Focused Photonics (Hangzhou) had liabilities of CN¥3.65b due within 12 months and liabilities of CN¥2.92b due beyond that. Offsetting this, it had CN¥988.6m in cash and CN¥1.45b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.13b.

This deficit is considerable relative to its market capitalization of CN¥6.70b, so it does suggest shareholders should keep an eye on Focused Photonics (Hangzhou)'s use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Focused Photonics (Hangzhou)'s ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Focused Photonics (Hangzhou) made a loss at the EBIT level, and saw its revenue drop to CN¥3.3b, which is a fall of 13%. We would much prefer see growth.

Caveat Emptor

Not only did Focused Photonics (Hangzhou)'s revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥358m at the EBIT level. 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¥9.7m in negative free cash flow over the last twelve months. So to be blunt we think it is 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. To that end, you should learn about the 2 warning signs we've spotted with Focused Photonics (Hangzhou) (including 1 which is concerning) .

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.