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. We can see that Guangdong Huicheng Vacuum Technology Co., Ltd. (SZSE:301392) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Guangdong Huicheng Vacuum Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Guangdong Huicheng Vacuum Technology had CN¥125.5m of debt, an increase on CN¥119.3m, over one year. But on the other hand it also has CN¥358.3m in cash, leading to a CN¥232.8m net cash position.

How Healthy Is Guangdong Huicheng Vacuum Technology's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Huicheng Vacuum Technology had liabilities of CN¥342.6m falling due within a year, and liabilities of CN¥60.7m due beyond that. Offsetting these obligations, it had cash of CN¥358.3m as well as receivables valued at CN¥268.8m due within 12 months. So it actually has CN¥223.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Huicheng Vacuum Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guangdong Huicheng Vacuum Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Guangdong Huicheng Vacuum Technology grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Guangdong Huicheng Vacuum Technology's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Guangdong Huicheng Vacuum Technology 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. During the last three years, Guangdong Huicheng Vacuum Technology produced sturdy free cash flow equating to 52% 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 we empathize with investors who find debt concerning, you should keep in mind that Guangdong Huicheng Vacuum Technology has net cash of CN¥232.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So is Guangdong Huicheng Vacuum Technology's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Guangdong Huicheng Vacuum Technology that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.