Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Chongqing Iron & Steel Company Limited (HKG:1053) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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

See our latest analysis for Chongqing Iron & Steel

How Much Debt Does Chongqing Iron & Steel Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Chongqing Iron & Steel had CN¥6.28b of debt, an increase on CN¥5.89b, over one year. However, it does have CN¥2.54b in cash offsetting this, leading to net debt of about CN¥3.74b.

A Look At Chongqing Iron & Steel's Liabilities

The latest balance sheet data shows that Chongqing Iron & Steel had liabilities of CN¥16.2b due within a year, and liabilities of CN¥1.30b falling due after that. Offsetting this, it had CN¥2.54b in cash and CN¥456.1m in receivables that were due within 12 months. So its liabilities total CN¥14.5b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's CN¥12.4b 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 it is Chongqing Iron & Steel'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, Chongqing Iron & Steel made a loss at the EBIT level, and saw its revenue drop to CN¥30b, which is a fall of 27%. That makes us nervous, to say the least.

Caveat Emptor

While Chongqing Iron & Steel'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 CN¥2.4b. When we look at that alongside the significant liabilities, we're not particularly confident 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 CN¥2.3b. In the meantime, we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Chongqing Iron & Steel you should be aware of.

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.

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