Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Gold cup Electric Apparatus Co.,Ltd. (SZSE:002533) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 Gold cup Electric ApparatusLtd

What Is Gold cup Electric ApparatusLtd's Net Debt?

As you can see below, Gold cup Electric ApparatusLtd had CN¥1.05b of debt at June 2022, down from CN¥1.38b a year prior. However, its balance sheet shows it holds CN¥1.37b in cash, so it actually has CN¥318.3m net cash.

How Healthy Is Gold cup Electric ApparatusLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Gold cup Electric ApparatusLtd had liabilities of CN¥3.72b due within 12 months and liabilities of CN¥608.2m due beyond that. Offsetting this, it had CN¥1.37b in cash and CN¥2.84b in receivables that were due within 12 months. So it has liabilities totalling CN¥120.8m more than its cash and near-term receivables, combined.

This state of affairs indicates that Gold cup Electric ApparatusLtd's 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¥6.08b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Gold cup Electric ApparatusLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Gold cup Electric ApparatusLtd grew its EBIT by 5.7% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is Gold cup Electric ApparatusLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Gold cup Electric ApparatusLtd 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, Gold cup Electric ApparatusLtd produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Gold cup Electric ApparatusLtd has CN¥318.3m in net cash. So we don't have any problem with Gold cup Electric ApparatusLtd's use of debt. 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 instance, we've identified 1 warning sign for Gold cup Electric ApparatusLtd that 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.

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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.