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 Guangzhou Kingmed Diagnostics Group Co., Ltd. (SHSE:603882) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guangzhou Kingmed Diagnostics Group

How Much Debt Does Guangzhou Kingmed Diagnostics Group Carry?

The chart below, which you can click on for greater detail, shows that Guangzhou Kingmed Diagnostics Group had CN¥457.5m in debt in March 2022; about the same as the year before. But on the other hand it also has CN¥2.47b in cash, leading to a CN¥2.01b net cash position.

A Look At Guangzhou Kingmed Diagnostics Group's Liabilities

According to the last reported balance sheet, Guangzhou Kingmed Diagnostics Group had liabilities of CN¥4.67b due within 12 months, and liabilities of CN¥443.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.47b as well as receivables valued at CN¥6.69b due within 12 months. So it actually has CN¥4.04b more liquid assets than total liabilities.

This short term liquidity is a sign that Guangzhou Kingmed Diagnostics Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guangzhou Kingmed Diagnostics Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Guangzhou Kingmed Diagnostics Group has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guangzhou Kingmed Diagnostics Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangzhou Kingmed Diagnostics Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Guangzhou Kingmed Diagnostics Group recorded free cash flow of 41% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangzhou Kingmed Diagnostics Group has net cash of CN¥2.01b, as well as more liquid assets than liabilities. And we liked the look of last year's 32% year-on-year EBIT growth. So we don't think Guangzhou Kingmed Diagnostics Group's use of debt is 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. For example, we've discovered 2 warning signs for Guangzhou Kingmed Diagnostics Group (1 is a bit concerning!) that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.