Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Guizhou RedStar Developing Co.,Ltd. (SHSE:600367) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guizhou RedStar DevelopingLtd Carry?

As you can see below, Guizhou RedStar DevelopingLtd had CN¥140.8m of debt at September 2024, down from CN¥272.1m a year prior. However, its balance sheet shows it holds CN¥943.7m in cash, so it actually has CN¥802.8m net cash.

How Healthy Is Guizhou RedStar DevelopingLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guizhou RedStar DevelopingLtd had liabilities of CN¥583.5m due within 12 months and liabilities of CN¥42.6m due beyond that. On the other hand, it had cash of CN¥943.7m and CN¥542.0m worth of receivables due within a year. So it actually has CN¥859.7m more liquid assets than total liabilities.

This excess liquidity suggests that Guizhou RedStar DevelopingLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Guizhou RedStar DevelopingLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Guizhou RedStar DevelopingLtd grew its EBIT by 251% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guizhou RedStar DevelopingLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guizhou RedStar DevelopingLtd 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 most recent three years, Guizhou RedStar DevelopingLtd recorded free cash flow worth 58% 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 Guizhou RedStar DevelopingLtd has net cash of CN¥802.8m, as well as more liquid assets than liabilities. And we liked the look of last year's 251% year-on-year EBIT growth. So is Guizhou RedStar DevelopingLtd'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. Case in point: We've spotted 1 warning sign for Guizhou RedStar DevelopingLtd you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.