Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Guoguang Electric Co.,Ltd.Chengdu (SHSE:688776) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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.

What Is Guoguang ElectricLtd.Chengdu's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guoguang ElectricLtd.Chengdu had debt of CN¥106.2m, up from CN¥30.0m in one year. But on the other hand it also has CN¥987.3m in cash, leading to a CN¥881.1m net cash position.

A Look At Guoguang ElectricLtd.Chengdu's Liabilities

Zooming in on the latest balance sheet data, we can see that Guoguang ElectricLtd.Chengdu had liabilities of CN¥409.7m due within 12 months and liabilities of CN¥109.7m due beyond that. Offsetting these obligations, it had cash of CN¥987.3m as well as receivables valued at CN¥881.6m due within 12 months. So it can boast CN¥1.35b more liquid assets than total liabilities.

This excess liquidity suggests that Guoguang ElectricLtd.Chengdu is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Guoguang ElectricLtd.Chengdu boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Guoguang ElectricLtd.Chengdu if management cannot prevent a repeat of the 50% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guoguang ElectricLtd.Chengdu'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guoguang ElectricLtd.Chengdu 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. In the last three years, Guoguang ElectricLtd.Chengdu created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guoguang ElectricLtd.Chengdu has net cash of CN¥881.1m, as well as more liquid assets than liabilities. So we don't have any problem with Guoguang ElectricLtd.Chengdu's use of debt. 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 Guoguang ElectricLtd.Chengdu's earnings per share history for free.

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.

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.

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