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.' 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. Importantly, Guizhou Space Appliance Co., LTD (SZSE:002025) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guizhou Space Appliance's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guizhou Space Appliance had debt of CN¥58.4m, up from CN¥30.0m in one year. But it also has CN¥2.97b in cash to offset that, meaning it has CN¥2.91b net cash.

How Healthy Is Guizhou Space Appliance's Balance Sheet?

According to the last reported balance sheet, Guizhou Space Appliance had liabilities of CN¥3.40b due within 12 months, and liabilities of CN¥474.6m due beyond 12 months. Offsetting this, it had CN¥2.97b in cash and CN¥5.56b in receivables that were due within 12 months. So it actually has CN¥4.66b more liquid assets than total liabilities.

This excess liquidity suggests that Guizhou Space Appliance is taking a careful approach to debt. 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 19% 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 it is future earnings, more than anything, that will determine Guizhou Space Appliance's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. During the last three years, Guizhou Space Appliance produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guizhou Space Appliance has CN¥2.91b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 19% over the last year. So is Guizhou Space Appliance's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Guizhou Space Appliance that you should be aware of.

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.

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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