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.' 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. We note that Goldcard Smart Group Co., Ltd. (SZSE:300349) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Goldcard Smart Group Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Goldcard Smart Group had debt of CN¥746.7m, up from CN¥350.9m in one year. But it also has CN¥1.54b in cash to offset that, meaning it has CN¥789.6m net cash.

How Strong Is Goldcard Smart Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Goldcard Smart Group had liabilities of CN¥2.01b due within 12 months and liabilities of CN¥529.8m due beyond that. Offsetting this, it had CN¥1.54b in cash and CN¥2.00b in receivables that were due within 12 months. So it can boast CN¥1.00b more liquid assets than total liabilities.

This excess liquidity suggests that Goldcard Smart Group 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 Goldcard Smart Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Goldcard Smart Group has boosted its EBIT by 34%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Goldcard Smart Group's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Goldcard Smart Group 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. Over the last three years, Goldcard Smart Group recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Goldcard Smart Group has CN¥789.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 34% over the last year. So is Goldcard Smart Group's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Goldcard Smart Group that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.

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