Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, South China Assets Holdings Limited (HKG:8155) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for South China Assets Holdings

What Is South China Assets Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that South China Assets Holdings had debt of HK$253.1m at the end of June 2019, a reduction from HK$392.3m over a year. However, it does have HK$40.3m in cash offsetting this, leading to net debt of about HK$212.8m.

How Strong Is South China Assets Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that South China Assets Holdings had liabilities of HK$134.7m due within 12 months and liabilities of HK$245.5m due beyond that. On the other hand, it had cash of HK$40.3m and HK$2.34m worth of receivables due within a year. So its liabilities total HK$337.6m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the HK$220.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, South China Assets Holdings would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is South China Assets Holdings'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.

In the last year South China Assets Holdings managed to grow its revenue by 888%, to HK$9.6m. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

Even though South China Assets Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. To be specific the EBIT loss came in at HK$6.0m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of HK$28m over the last twelve months. So suffice it to say we consider the stock to be risky. For riskier companies like South China Assets Holdings I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.

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.