The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, Jiangxi Guoke Defence Group Co.,Ltd. (SHSE:688543) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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.

What Is Jiangxi Guoke Defence GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Jiangxi Guoke Defence GroupLtd had debt of CN¥80.3m at the end of March 2024, a reduction from CN¥409.1m over a year. But on the other hand it also has CN¥1.46b in cash, leading to a CN¥1.38b net cash position.

How Healthy Is Jiangxi Guoke Defence GroupLtd's Balance Sheet?

According to the last reported balance sheet, Jiangxi Guoke Defence GroupLtd had liabilities of CN¥669.4m due within 12 months, and liabilities of CN¥66.0m due beyond 12 months. Offsetting this, it had CN¥1.46b in cash and CN¥344.6m in receivables that were due within 12 months. So it can boast CN¥1.07b more liquid assets than total liabilities.

This surplus suggests that Jiangxi Guoke Defence GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Jiangxi Guoke Defence GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Jiangxi Guoke Defence GroupLtd grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jiangxi Guoke Defence GroupLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Jiangxi Guoke Defence GroupLtd 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. Looking at the most recent three years, Jiangxi Guoke Defence GroupLtd recorded free cash flow of 43% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangxi Guoke Defence GroupLtd has CN¥1.38b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 36% over the last year. So we don't think Jiangxi Guoke Defence GroupLtd's use of debt is risky. Over time, share prices tend to follow earnings per share, so if you're interested in Jiangxi Guoke Defence GroupLtd, 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.

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