David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sinostone(Guangdong) Co.,Ltd. (SZSE:001212) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Sinostone(Guangdong)Ltd's Debt?

As you can see below, at the end of September 2023, Sinostone(Guangdong)Ltd had CN¥416.5m of debt, up from CN¥16.4m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.07b in cash, so it actually has CN¥655.6m net cash.

A Look At Sinostone(Guangdong)Ltd's Liabilities

We can see from the most recent balance sheet that Sinostone(Guangdong)Ltd had liabilities of CN¥147.3m falling due within a year, and liabilities of CN¥451.5m due beyond that. Offsetting this, it had CN¥1.07b in cash and CN¥167.2m in receivables that were due within 12 months. So it actually has CN¥640.5m more liquid assets than total liabilities.

This excess liquidity suggests that Sinostone(Guangdong)Ltd is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Sinostone(Guangdong)Ltd boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Sinostone(Guangdong)Ltd's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sinostone(Guangdong)Ltd 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. Sinostone(Guangdong)Ltd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sinostone(Guangdong)Ltd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sinostone(Guangdong)Ltd has net cash of CN¥655.6m, as well as more liquid assets than liabilities. So we are not troubled with Sinostone(Guangdong)Ltd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. 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 3 warning signs for Sinostone(Guangdong)Ltd (of which 2 are a bit concerning!) 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.