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. 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. As with many other companies China LotSynergy Holdings Limited (HKG:1371) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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 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.

Check out our latest analysis for China LotSynergy Holdings

How Much Debt Does China LotSynergy Holdings Carry?

The image below, which you can click on for greater detail, shows that at June 2019 China LotSynergy Holdings had debt of HK$427.3m, up from HK$312.2m in one year. However, it also had HK$106.7m in cash, and so its net debt is HK$320.6m.

How Healthy Is China LotSynergy Holdings's Balance Sheet?

The latest balance sheet data shows that China LotSynergy Holdings had liabilities of HK$500.6m due within a year, and liabilities of HK$46.1m falling due after that. Offsetting this, it had HK$106.7m in cash and HK$96.6m in receivables that were due within 12 months. So its liabilities total HK$343.4m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$249.8m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since China LotSynergy Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year China LotSynergy Holdings had negative earnings before interest and tax, and actually shrunk its revenue by 22%, to HK$179m. That makes us nervous, to say the least.

Caveat Emptor

While China LotSynergy Holdings's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$81m. Considering that alongside the liabilities mentioned above make us nervous 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 HK$148m. In the meantime, we consider the stock to be risky. For riskier companies like China LotSynergy Holdings I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.