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.' 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 can see that Greentown Service Group Co. Ltd. (HKG:2869) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Greentown Service Group's Net Debt?

The image below, which you can click on for greater detail, shows that Greentown Service Group had debt of CN¥313.5m at the end of December 2023, a reduction from CN¥333.6m over a year. However, its balance sheet shows it holds CN¥5.69b in cash, so it actually has CN¥5.38b net cash.

How Strong Is Greentown Service Group's Balance Sheet?

We can see from the most recent balance sheet that Greentown Service Group had liabilities of CN¥8.56b falling due within a year, and liabilities of CN¥1.30b due beyond that. Offsetting this, it had CN¥5.69b in cash and CN¥4.35b in receivables that were due within 12 months. So these liquid assets roughly match the total liabilities.

Having regard to Greentown Service Group's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥13.8b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Greentown Service Group has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Greentown Service Group grew its EBIT at 16% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Greentown Service Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Greentown Service Group 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 most recent three years, Greentown Service Group recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 Greentown Service Group has net cash of CN¥5.38b, as well as more liquid assets than liabilities. The cherry on top was that in converted 68% of that EBIT to free cash flow, bringing in CN¥933m. So is Greentown Service Group's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Greentown Service Group you should know about.

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.