Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangdong KinLong Hardware Products Co.,Ltd. (SZSE:002791) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. 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 Guangdong KinLong Hardware ProductsLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Guangdong KinLong Hardware ProductsLtd had debt of CN¥318.2m at the end of December 2023, a reduction from CN¥727.3m over a year. However, its balance sheet shows it holds CN¥1.41b in cash, so it actually has CN¥1.09b net cash.

A Look At Guangdong KinLong Hardware ProductsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangdong KinLong Hardware ProductsLtd had liabilities of CN¥4.06b due within 12 months and liabilities of CN¥425.2m due beyond that. Offsetting this, it had CN¥1.41b in cash and CN¥4.14b in receivables that were due within 12 months. So it can boast CN¥1.06b more liquid assets than total liabilities.

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

Better yet, Guangdong KinLong Hardware ProductsLtd grew its EBIT by 186% last year, which is an impressive improvement. That boost will make it even 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 KinLong Hardware ProductsLtd'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. Guangdong KinLong Hardware ProductsLtd 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. Looking at the most recent three years, Guangdong KinLong Hardware ProductsLtd recorded free cash flow of 44% of its EBIT, which is weaker 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 KinLong Hardware ProductsLtd has net cash of CN¥1.09b, as well as more liquid assets than liabilities. And we liked the look of last year's 186% year-on-year EBIT growth. So is Guangdong KinLong Hardware ProductsLtd's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Guangdong KinLong Hardware ProductsLtd, you may well want to click here to check an interactive graph of its earnings per share history.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.