Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Qtone Education Group (Guangdong) Co.,Ltd (SZSE:300359) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Qtone Education Group (Guangdong)Ltd

How Much Debt Does Qtone Education Group (Guangdong)Ltd Carry?

The image below, which you can click on for greater detail, shows that Qtone Education Group (Guangdong)Ltd had debt of CN¥45.0m at the end of September 2022, a reduction from CN¥153.6m over a year. However, it does have CN¥396.5m in cash offsetting this, leading to net cash of CN¥351.5m.

How Healthy Is Qtone Education Group (Guangdong)Ltd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qtone Education Group (Guangdong)Ltd had liabilities of CN¥298.1m due within 12 months and liabilities of CN¥25.7m due beyond that. Offsetting this, it had CN¥396.5m in cash and CN¥387.8m in receivables that were due within 12 months. So it can boast CN¥460.5m more liquid assets than total liabilities.

This surplus suggests that Qtone Education Group (Guangdong)Ltd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Qtone Education Group (Guangdong)Ltd has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Qtone Education Group (Guangdong)Ltd's load is not too heavy, because its EBIT was down 45% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Qtone Education Group (Guangdong)Ltd's earnings that will influence how the balance sheet holds up in the future. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Qtone Education Group (Guangdong)Ltd 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 two years, Qtone Education Group (Guangdong)Ltd actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Qtone Education Group (Guangdong)Ltd has net cash of CN¥351.5m, as well as more liquid assets than liabilities. The cherry on top was that in converted 324% of that EBIT to free cash flow, bringing in CN¥83m. So we are not troubled with Qtone Education Group (Guangdong)Ltd's debt use. 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. Case in point: We've spotted 2 warning signs for Qtone Education Group (Guangdong)Ltd you should be aware of, and 1 of them is a bit concerning.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.