Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Creative China Holdings Limited (HKG:8368) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

See our latest analysis for Creative China Holdings

What Is Creative China Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2019 Creative China Holdings had CN¥10.2m of debt, an increase on none, over one year. On the flip side, it has CN¥3.46m in cash leading to net debt of about CN¥6.75m.

A Look At Creative China Holdings's Liabilities

The latest balance sheet data shows that Creative China Holdings had liabilities of CN¥94.5m due within a year, and liabilities of CN¥6.73m falling due after that. Offsetting these obligations, it had cash of CN¥3.46m as well as receivables valued at CN¥48.2m due within 12 months. So it has liabilities totalling CN¥49.6m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Creative China Holdings is worth CN¥109.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But it is Creative China Holdings'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.

In the last year Creative China Holdings managed to grow its revenue by 173%, to CN¥59m. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

While we can certainly savour Creative China Holdings's tasty revenue growth, its negative earnings before interest and tax (EBIT) leaves a bitter aftertaste. Indeed, it lost a very considerable CN¥22m 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. However, it doesn't help that it burned through CN¥24m of cash over the last year. So in short it's a really risky stock. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Creative China Holdings's profit, revenue, and operating cashflow have changed over the last few years.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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.