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 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, Guangdong Huate Gas Co., Ltd (SHSE:688268) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Guangdong Huate Gas

What Is Guangdong Huate Gas's Net Debt?

As you can see below, at the end of June 2022, Guangdong Huate Gas had CN¥232.7m of debt, up from CN¥19.7m a year ago. Click the image for more detail. But it also has CN¥362.0m in cash to offset that, meaning it has CN¥129.3m net cash.

How Strong Is Guangdong Huate Gas' Balance Sheet?

The latest balance sheet data shows that Guangdong Huate Gas had liabilities of CN¥408.4m due within a year, and liabilities of CN¥193.1m falling due after that. Offsetting these obligations, it had cash of CN¥362.0m as well as receivables valued at CN¥428.4m due within 12 months. So it actually has CN¥189.0m more liquid assets than total liabilities.

This state of affairs indicates that Guangdong Huate Gas' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥10.5b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Guangdong Huate Gas boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Guangdong Huate Gas grew its EBIT by 54% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guangdong Huate Gas 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. Guangdong Huate Gas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Guangdong Huate Gas burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong Huate Gas has CN¥129.3m in net cash and a decent-looking balance sheet. And we liked the look of last year's 54% year-on-year EBIT growth. So we are not troubled with Guangdong Huate Gas's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Guangdong Huate Gas (at least 1 which is concerning) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.