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. We can see that Guangdong Guanghua Sci-Tech Co., Ltd. (SZSE:002741) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

What Is Guangdong Guanghua Sci-Tech's Debt?

As you can see below, Guangdong Guanghua Sci-Tech had CN¥885.1m of debt at June 2024, down from CN¥933.4m a year prior. However, it does have CN¥237.8m in cash offsetting this, leading to net debt of about CN¥647.3m.

How Healthy Is Guangdong Guanghua Sci-Tech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong Guanghua Sci-Tech had liabilities of CN¥1.47b due within 12 months and liabilities of CN¥238.0m due beyond that. Offsetting this, it had CN¥237.8m in cash and CN¥718.4m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥749.3m.

Of course, Guangdong Guanghua Sci-Tech has a market capitalization of CN¥4.29b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Guangdong Guanghua Sci-Tech'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.

In the last year Guangdong Guanghua Sci-Tech had a loss before interest and tax, and actually shrunk its revenue by 7.1%, to CN¥2.6b. We would much prefer see growth.

Caveat Emptor

Over the last twelve months Guangdong Guanghua Sci-Tech produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥294m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥124m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Guangdong Guanghua Sci-Tech (of which 1 is 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.