The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies Guangzhou Sie Consulting Co., Ltd. (SZSE:300687) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Guangzhou Sie Consulting Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Guangzhou Sie Consulting had CN¥428.7m of debt, an increase on CN¥295.7m, over one year. On the flip side, it has CN¥416.9m in cash leading to net debt of about CN¥11.8m.

How Strong Is Guangzhou Sie Consulting's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangzhou Sie Consulting had liabilities of CN¥529.5m due within 12 months and liabilities of CN¥306.7m due beyond that. Offsetting these obligations, it had cash of CN¥416.9m as well as receivables valued at CN¥1.13b due within 12 months. So it can boast CN¥713.7m more liquid assets than total liabilities.

This surplus suggests that Guangzhou Sie Consulting has a conservative balance sheet, and could probably eliminate its debt without much difficulty. But either way, Guangzhou Sie Consulting has virtually no net debt, so it's fair to say it does not have a heavy debt load!

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With debt at a measly 0.072 times EBITDA and EBIT covering interest a whopping 118 times, it's clear that Guangzhou Sie Consulting is not a desperate borrower. So relative to past earnings, the debt load seems trivial. In fact Guangzhou Sie Consulting's saving grace is its low debt levels, because its EBIT has tanked 32% in the last twelve months. 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 future earnings, more than anything, that will determine Guangzhou Sie Consulting's ability to maintain a healthy balance sheet going forward. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Guangzhou Sie Consulting saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We feel some trepidation about Guangzhou Sie Consulting's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. We think that Guangzhou Sie Consulting's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example - Guangzhou Sie Consulting has 3 warning signs we think you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.