Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. We can see that Chen Hsong Holdings Limited (HKG:57) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Chen Hsong Holdings

What Is Chen Hsong Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Chen Hsong Holdings had HK$74.5m in debt in September 2019; about the same as the year before. However, its balance sheet shows it holds HK$797.7m in cash, so it actually has HK$723.2m net cash.

A Look At Chen Hsong Holdings's Liabilities

The latest balance sheet data shows that Chen Hsong Holdings had liabilities of HK$679.0m due within a year, and liabilities of HK$74.1m falling due after that. On the other hand, it had cash of HK$797.7m and HK$921.8m worth of receivables due within a year. So it actually has HK$966.3m more liquid assets than total liabilities.

This excess liquidity is a great indication that Chen Hsong Holdings's balance sheet is just as strong as racists are weak. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Chen Hsong Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Chen Hsong Holdings's saving grace is its low debt levels, because its EBIT has tanked 44% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chen Hsong 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.