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 Guangxi Yuegui Guangye Holdings Co., Ltd. (SZSE:000833) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

What Is Guangxi Yuegui Guangye Holdings's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guangxi Yuegui Guangye Holdings had debt of CN¥1.57b, up from CN¥1.20b in one year. However, because it has a cash reserve of CN¥1.51b, its net debt is less, at about CN¥60.7m.

A Look At Guangxi Yuegui Guangye Holdings' Liabilities

The latest balance sheet data shows that Guangxi Yuegui Guangye Holdings had liabilities of CN¥1.85b due within a year, and liabilities of CN¥441.1m falling due after that. Offsetting these obligations, it had cash of CN¥1.51b as well as receivables valued at CN¥348.2m due within 12 months. So it has liabilities totalling CN¥424.9m more than its cash and near-term receivables, combined.

Given Guangxi Yuegui Guangye Holdings has a market capitalization of CN¥3.92b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Guangxi Yuegui Guangye Holdings's low debt to EBITDA ratio of 0.17 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.0 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Importantly, Guangxi Yuegui Guangye Holdings's EBIT fell a jaw-dropping 50% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Guangxi Yuegui Guangye Holdings will need earnings to service that debt. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Guangxi Yuegui Guangye Holdings's free cash flow amounted to 32% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Guangxi Yuegui Guangye Holdings's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its net debt to EBITDA was re-invigorating. We think that Guangxi Yuegui Guangye Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with Guangxi Yuegui Guangye Holdings .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.