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 note that GoodWe Technologies Co., Ltd. (SHSE:688390) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

What Is GoodWe Technologies's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 GoodWe Technologies had CN¥295.4m of debt, an increase on CN¥60.1m, over one year. However, its balance sheet shows it holds CN¥906.9m in cash, so it actually has CN¥611.5m net cash.

How Healthy Is GoodWe Technologies' Balance Sheet?

We can see from the most recent balance sheet that GoodWe Technologies had liabilities of CN¥3.21b falling due within a year, and liabilities of CN¥515.4m due beyond that. Offsetting this, it had CN¥906.9m in cash and CN¥992.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥1.83b more than its cash and near-term receivables, combined.

Since publicly traded GoodWe Technologies shares are worth a total of CN¥18.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, GoodWe Technologies boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for GoodWe Technologies if management cannot prevent a repeat of the 54% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 GoodWe Technologies 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While GoodWe Technologies has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, GoodWe Technologies reported free cash flow worth 2.6% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

We could understand if investors are concerned about GoodWe Technologies's liabilities, but we can be reassured by the fact it has has net cash of CN¥611.5m. So while GoodWe Technologies does not have a great balance sheet, it's certainly not too bad. 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 3 warning signs for GoodWe Technologies (of which 1 can't be ignored!) 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.