Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Guangdong Mingyang Electric Co.,Ltd. (SZSE:301291) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 Mingyang ElectricLtd Carry?

As you can see below, Guangdong Mingyang ElectricLtd had CN¥160.3m of debt at March 2024, down from CN¥432.7m a year prior. However, it does have CN¥2.88b in cash offsetting this, leading to net cash of CN¥2.72b.

A Look At Guangdong Mingyang ElectricLtd's Liabilities

According to the last reported balance sheet, Guangdong Mingyang ElectricLtd had liabilities of CN¥3.46b due within 12 months, and liabilities of CN¥66.3m due beyond 12 months. Offsetting this, it had CN¥2.88b in cash and CN¥2.75b in receivables that were due within 12 months. So it can boast CN¥2.11b more liquid assets than total liabilities.

This excess liquidity suggests that Guangdong Mingyang ElectricLtd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Guangdong Mingyang ElectricLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Guangdong Mingyang ElectricLtd has boosted its EBIT by 76%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangdong Mingyang ElectricLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guangdong Mingyang ElectricLtd 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. In the last three years, Guangdong Mingyang ElectricLtd's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Mingyang ElectricLtd has net cash of CN¥2.72b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 76% over the last year. So we don't think Guangdong Mingyang ElectricLtd's use of debt is risky. 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. For example - Guangdong Mingyang ElectricLtd has 1 warning sign we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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