Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 GCL System Integration Technology Co., Ltd. (SZSE:002506) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for GCL System Integration Technology

What Is GCL System Integration Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 GCL System Integration Technology had debt of CN¥2.30b, up from CN¥2.15b in one year. But it also has CN¥3.42b in cash to offset that, meaning it has CN¥1.12b net cash.

How Healthy Is GCL System Integration Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that GCL System Integration Technology had liabilities of CN¥7.78b due within 12 months and liabilities of CN¥1.36b due beyond that. On the other hand, it had cash of CN¥3.42b and CN¥1.52b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥4.22b.

This deficit isn't so bad because GCL System Integration Technology is worth CN¥16.2b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, GCL System Integration Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, GCL System Integration Technology turned things around in the last 12 months, delivering and EBIT of CN¥141m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine GCL System Integration Technology's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GCL System Integration Technology 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. Over the last year, GCL System Integration Technology actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While GCL System Integration Technology does have more liabilities than liquid assets, it also has net cash of CN¥1.12b. And it impressed us with free cash flow of CN¥177m, being 126% of its EBIT. So we don't think GCL System Integration Technology's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of GCL System Integration Technology's earnings per share history for free.

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.