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.' 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 can see that Guizhou Space Appliance Co., LTD (SZSE:002025) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Guizhou Space Appliance's Net Debt?
As you can see below, at the end of September 2023, Guizhou Space Appliance had CN¥360.0m of debt, up from none a year ago. Click the image for more detail. However, it does have CN¥1.94b in cash offsetting this, leading to net cash of CN¥1.58b.
How Healthy Is Guizhou Space Appliance's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Guizhou Space Appliance had liabilities of CN¥3.56b due within 12 months and liabilities of CN¥400.4m due beyond that. On the other hand, it had cash of CN¥1.94b and CN¥6.50b worth of receivables due within a year. So it actually has CN¥4.49b more liquid assets than total liabilities.
It's good to see that Guizhou Space Appliance has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Guizhou Space Appliance has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Guizhou Space Appliance grew its EBIT by 18% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guizhou Space Appliance can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Guizhou Space Appliance 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 three years, Guizhou Space Appliance reported free cash flow worth 3.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that Guizhou Space Appliance has net cash of CN¥1.58b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 18% over the last year. So we don't think Guizhou Space Appliance's use of debt is risky. 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 example, we've discovered 1 warning sign for Guizhou Space Appliance that you should be aware of before investing here.
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.