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.' 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. As with many other companies Gongniu Group Co.,Ltd. (SHSE:603195) makes use of debt. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Gongniu GroupLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Gongniu GroupLtd had debt of CN¥688.4m at the end of March 2024, a reduction from CN¥879.4m over a year. But on the other hand it also has CN¥15.9b in cash, leading to a CN¥15.2b net cash position.

How Healthy Is Gongniu GroupLtd's Balance Sheet?

According to the last reported balance sheet, Gongniu GroupLtd had liabilities of CN¥5.63b due within 12 months, and liabilities of CN¥237.0m due beyond 12 months. Offsetting this, it had CN¥15.9b in cash and CN¥348.9m in receivables that were due within 12 months. So it actually has CN¥10.4b more liquid assets than total liabilities.

This surplus suggests that Gongniu GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Gongniu GroupLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also positive, Gongniu GroupLtd grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. 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 Gongniu GroupLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Gongniu GroupLtd 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 three years, Gongniu GroupLtd recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Gongniu GroupLtd has CN¥15.2b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥4.2b. So we don't think Gongniu GroupLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Gongniu GroupLtd you should be aware of.

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.