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.' 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. Importantly, Guangdong Homa Group Co., Ltd. (SZSE:002668) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guangdong Homa Group Carry?

You can click the graphic below for the historical numbers, but it shows that Guangdong Homa Group had CN¥300.8m of debt in September 2023, down from CN¥2.08b, one year before. However, its balance sheet shows it holds CN¥3.53b in cash, so it actually has CN¥3.22b net cash.

How Strong Is Guangdong Homa Group's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Homa Group had liabilities of CN¥5.68b falling due within a year, and liabilities of CN¥263.2m due beyond that. Offsetting this, it had CN¥3.53b in cash and CN¥2.13b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥288.7m.

Of course, Guangdong Homa Group has a market capitalization of CN¥7.70b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Guangdong Homa Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Guangdong Homa Group grew its EBIT by 146% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Guangdong Homa Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Guangdong Homa Group 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 two years, Guangdong Homa Group generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Guangdong Homa Group has CN¥3.22b in net cash. And it impressed us with free cash flow of CN¥1.6b, being 82% of its EBIT. So is Guangdong Homa Group's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Guangdong Homa Group, you may well want to click here to check an interactive graph of its earnings per share history.

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.