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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Gold cup Electric Apparatus Co.,Ltd. (SZSE:002533) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Gold cup Electric ApparatusLtd's Debt?

The image below, which you can click on for greater detail, shows that Gold cup Electric ApparatusLtd had debt of CN¥1.06b at the end of September 2024, a reduction from CN¥1.11b over a year. But on the other hand it also has CN¥1.58b in cash, leading to a CN¥519.8m net cash position.

How Strong Is Gold cup Electric ApparatusLtd's Balance Sheet?

We can see from the most recent balance sheet that Gold cup Electric ApparatusLtd had liabilities of CN¥5.01b falling due within a year, and liabilities of CN¥901.4m due beyond that. Offsetting this, it had CN¥1.58b in cash and CN¥4.04b in receivables that were due within 12 months. So its liabilities total CN¥289.6m more than the combination of its cash and short-term receivables.

Given Gold cup Electric ApparatusLtd has a market capitalization of CN¥7.68b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Gold cup Electric ApparatusLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Gold cup Electric ApparatusLtd grew its EBIT at 15% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gold cup Electric ApparatusLtd 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. Gold cup Electric ApparatusLtd 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, Gold cup Electric ApparatusLtd's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Gold cup Electric ApparatusLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥519.8m. On top of that, it increased its EBIT by 15% in the last twelve months. So we don't think Gold cup Electric ApparatusLtd's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Gold cup Electric ApparatusLtd you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.