Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangdong Advertising Group Co.,Ltd (SZSE:002400) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Guangdong Advertising GroupLtd

What Is Guangdong Advertising GroupLtd's Net Debt?

As you can see below, at the end of September 2023, Guangdong Advertising GroupLtd had CN¥1.02b of debt, up from CN¥26.7m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥214.1m, its net debt is less, at about CN¥805.7m.

How Healthy Is Guangdong Advertising GroupLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong Advertising GroupLtd had liabilities of CN¥3.41b due within 12 months and liabilities of CN¥320.2m due beyond that. On the other hand, it had cash of CN¥214.1m and CN¥3.82b worth of receivables due within a year. So it actually has CN¥300.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Advertising GroupLtd could probably pay off its debt with ease, as its balance sheet is far from stretched.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Guangdong Advertising GroupLtd's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its strong interest cover of 31.3 times, makes us even more comfortable. Notably, Guangdong Advertising GroupLtd's EBIT launched higher than Elon Musk, gaining a whopping 143% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Guangdong Advertising GroupLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Guangdong Advertising GroupLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Guangdong Advertising GroupLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But we must concede we find its conversion of EBIT to free cash flow has the opposite effect. Looking at all the aforementioned factors together, it strikes us that Guangdong Advertising GroupLtd can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Guangdong Advertising GroupLtd has 3 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.