David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Guangdong Huate Gas Co., Ltd (SHSE:688268) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangdong Huate Gas's Net Debt?

The chart below, which you can click on for greater detail, shows that Guangdong Huate Gas had CN¥797.1m in debt in June 2024; about the same as the year before. However, it does have CN¥1.01b in cash offsetting this, leading to net cash of CN¥215.6m.

A Look At Guangdong Huate Gas' Liabilities

Zooming in on the latest balance sheet data, we can see that Guangdong Huate Gas had liabilities of CN¥377.2m due within 12 months and liabilities of CN¥869.9m due beyond that. On the other hand, it had cash of CN¥1.01b and CN¥445.4m worth of receivables due within a year. So it actually has CN¥211.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Huate Gas could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangdong Huate Gas boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Guangdong Huate Gas grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong Huate Gas'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Guangdong Huate Gas 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. Over the last three years, Guangdong Huate Gas recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Huate Gas has net cash of CN¥215.6m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 21% over the last year. So we are not troubled with Guangdong Huate Gas's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Guangdong Huate Gas that 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.