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.' 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. We note that XiaMen HongXin Electron-tech Group Co.,Ltd (SZSE:300657) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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 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, 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 think about a company's use of debt, we first look at cash and debt together.

What Is XiaMen HongXin Electron-tech GroupLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 XiaMen HongXin Electron-tech GroupLtd had debt of CN¥1.38b, up from CN¥1.18b in one year. However, it also had CN¥670.9m in cash, and so its net debt is CN¥713.8m.

How Healthy Is XiaMen HongXin Electron-tech GroupLtd's Balance Sheet?

According to the last reported balance sheet, XiaMen HongXin Electron-tech GroupLtd had liabilities of CN¥3.29b due within 12 months, and liabilities of CN¥423.6m due beyond 12 months. Offsetting this, it had CN¥670.9m in cash and CN¥1.81b in receivables that were due within 12 months. So it has liabilities totalling CN¥1.23b more than its cash and near-term receivables, combined.

Of course, XiaMen HongXin Electron-tech GroupLtd has a market capitalization of CN¥7.59b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But it is XiaMen HongXin Electron-tech GroupLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, XiaMen HongXin Electron-tech GroupLtd reported revenue of CN¥4.5b, which is a gain of 70%, 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.

Caveat Emptor

While we can certainly appreciate XiaMen HongXin Electron-tech GroupLtd's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. To be specific the EBIT loss came in at CN¥173m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥76m of cash over the last year. So suffice it to say we do consider the stock to be 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. For example, we've discovered 1 warning sign for XiaMen HongXin Electron-tech GroupLtd that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com