Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Beijing Digital Telecom Co., Ltd. (HKG:6188) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Beijing Digital Telecom

How Much Debt Does Beijing Digital Telecom Carry?

As you can see below, Beijing Digital Telecom had CN¥3.60b of debt at June 2019, down from CN¥3.77b a year prior. However, because it has a cash reserve of CN¥518.4m, its net debt is less, at about CN¥3.08b.

How Healthy Is Beijing Digital Telecom's Balance Sheet?

According to the last reported balance sheet, Beijing Digital Telecom had liabilities of CN¥5.23b due within 12 months, and liabilities of CN¥322.7m due beyond 12 months. On the other hand, it had cash of CN¥518.4m and CN¥2.68b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.35b.

This deficit casts a shadow over the CN¥1.48b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt After all, Beijing Digital Telecom would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 5.2, it's fair to say Beijing Digital Telecom does have a significant amount of debt. However, its interest coverage of 2.8 is reasonably strong, which is a good sign. Even more troubling is the fact that Beijing Digital Telecom actually let its EBIT decrease by 5.2% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Beijing Digital Telecom'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.