David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that GCL System Integration Technology Co., Ltd. (SZSE:002506) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for GCL System Integration Technology

What Is GCL System Integration Technology's Debt?

As you can see below, GCL System Integration Technology had CN¥2.20b of debt at September 2023, down from CN¥2.37b a year prior. But it also has CN¥5.03b in cash to offset that, meaning it has CN¥2.83b net cash.

A Look At GCL System Integration Technology's Liabilities

We can see from the most recent balance sheet that GCL System Integration Technology had liabilities of CN¥10.3b falling due within a year, and liabilities of CN¥1.48b due beyond that. Offsetting these obligations, it had cash of CN¥5.03b as well as receivables valued at CN¥1.65b due within 12 months. So its liabilities total CN¥5.07b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since GCL System Integration Technology has a market capitalization of CN¥15.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, GCL System Integration Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Although GCL System Integration Technology made a loss at the EBIT level, last year, it was also good to see that it generated CN¥223m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is GCL System Integration Technology's earnings that will influence how the balance sheet holds up in the future. 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. GCL System Integration Technology 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. 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

Although GCL System Integration Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥2.83b. And it impressed us with free cash flow of CN¥482m, being 216% of its EBIT. So we are not troubled with GCL System Integration Technology's debt use. 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. Be aware that GCL System Integration Technology is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.