Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Guangdong Dongfang Precision Science & Technology Co., Ltd. (SZSE:002611) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guangdong Dongfang Precision Science & Technology Carry?

The chart below, which you can click on for greater detail, shows that Guangdong Dongfang Precision Science & Technology had CN¥478.4m in debt in March 2024; about the same as the year before. But on the other hand it also has CN¥2.30b in cash, leading to a CN¥1.82b net cash position.

A Look At Guangdong Dongfang Precision Science & Technology's Liabilities

According to the last reported balance sheet, Guangdong Dongfang Precision Science & Technology had liabilities of CN¥2.24b due within 12 months, and liabilities of CN¥348.0m due beyond 12 months. On the other hand, it had cash of CN¥2.30b and CN¥902.3m worth of receivables due within a year. So it can boast CN¥614.6m more liquid assets than total liabilities.

This surplus suggests that Guangdong Dongfang Precision Science & Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guangdong Dongfang Precision Science & Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Guangdong Dongfang Precision Science & Technology has been able to increase its EBIT by 30% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is Guangdong Dongfang Precision Science & 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Guangdong Dongfang Precision Science & 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. In the last three years, Guangdong Dongfang Precision Science & Technology's free cash flow amounted to 40% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Dongfang Precision Science & Technology has net cash of CN¥1.82b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 30% over the last year. So we don't think Guangdong Dongfang Precision Science & Technology's use of debt is risky. 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. We've identified 2 warning signs with Guangdong Dongfang Precision Science & Technology (at least 1 which is significant) , and understanding them should be part of your investment process.

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.