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.' 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. Importantly, Zhongfu Information Inc. (SZSE:300659) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Zhongfu Information's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Zhongfu Information had CN¥200.2m of debt in March 2024, down from CN¥331.7m, one year before. However, its balance sheet shows it holds CN¥571.8m in cash, so it actually has CN¥371.6m net cash.

How Healthy Is Zhongfu Information's Balance Sheet?

According to the last reported balance sheet, Zhongfu Information had liabilities of CN¥496.6m due within 12 months, and liabilities of CN¥36.0m due beyond 12 months. Offsetting this, it had CN¥571.8m in cash and CN¥489.3m in receivables that were due within 12 months. So it actually has CN¥528.5m more liquid assets than total liabilities.

This surplus suggests that Zhongfu Information has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhongfu Information has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Zhongfu Information's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Zhongfu Information reported revenue of CN¥913m, which is a gain of 29%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Zhongfu Information?

Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Zhongfu Information lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through CN¥179m of cash and made a loss of CN¥145m. While this does make the company a bit risky, it's important to remember it has net cash of CN¥371.6m. That means it could keep spending at its current rate for more than two years. Zhongfu Information's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. 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. For instance, we've identified 3 warning signs for Zhongfu Information (1 can't be ignored) 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.