The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Hunan Friendship&Apollo Commercial Co.,Ltd. (SZSE:002277) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Hunan Friendship&Apollo CommercialLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Hunan Friendship&Apollo CommercialLtd had CN¥4.46b of debt, an increase on CN¥4.25b, over one year. However, it does have CN¥331.4m in cash offsetting this, leading to net debt of about CN¥4.13b.

A Look At Hunan Friendship&Apollo CommercialLtd's Liabilities

The latest balance sheet data shows that Hunan Friendship&Apollo CommercialLtd had liabilities of CN¥4.92b due within a year, and liabilities of CN¥2.89b falling due after that. On the other hand, it had cash of CN¥331.4m and CN¥314.4m worth of receivables due within a year. So its liabilities total CN¥7.17b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the CN¥3.69b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Hunan Friendship&Apollo CommercialLtd would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Hunan Friendship&Apollo CommercialLtd 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.

In the last year Hunan Friendship&Apollo CommercialLtd had a loss before interest and tax, and actually shrunk its revenue by 38%, to CN¥1.3b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Hunan Friendship&Apollo CommercialLtd's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost CN¥116m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. For example, we would not want to see a repeat of last year's loss of CN¥17m. And until that time we think this is a risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Hunan Friendship&Apollo CommercialLtd you should be aware of.

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.