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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Guangdong KinLong Hardware Products Co.,Ltd. (SZSE:002791) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangdong KinLong Hardware ProductsLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that Guangdong KinLong Hardware ProductsLtd had CN¥326.1m of debt in September 2024, down from CN¥553.1m, one year before. However, it does have CN¥1.41b in cash offsetting this, leading to net cash of CN¥1.08b.

A Look At Guangdong KinLong Hardware ProductsLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangdong KinLong Hardware ProductsLtd had liabilities of CN¥3.92b due within 12 months and liabilities of CN¥326.3m due beyond that. Offsetting these obligations, it had cash of CN¥1.41b as well as receivables valued at CN¥4.19b due within 12 months. So it actually has CN¥1.35b more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong KinLong Hardware ProductsLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangdong KinLong Hardware ProductsLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Guangdong KinLong Hardware ProductsLtd has seen its EBIT plunge 11% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Guangdong KinLong Hardware ProductsLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong KinLong Hardware ProductsLtd 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. Happily for any shareholders, Guangdong KinLong Hardware ProductsLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong KinLong Hardware ProductsLtd has CN¥1.08b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 143% of that EBIT to free cash flow, bringing in CN¥230m. So we don't think Guangdong KinLong Hardware ProductsLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Guangdong KinLong Hardware ProductsLtd 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.