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. We note that Guangdong Create Century Intelligent Equipment Group Corporation Limited (SZSE:300083) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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.

What Is Guangdong Create Century Intelligent Equipment Group's Debt?

The image below, which you can click on for greater detail, shows that Guangdong Create Century Intelligent Equipment Group had debt of CN¥1.47b at the end of September 2024, a reduction from CN¥1.57b over a year. However, it also had CN¥903.5m in cash, and so its net debt is CN¥570.4m.

How Strong Is Guangdong Create Century Intelligent Equipment Group's Balance Sheet?

According to the last reported balance sheet, Guangdong Create Century Intelligent Equipment Group had liabilities of CN¥4.28b due within 12 months, and liabilities of CN¥1.00b due beyond 12 months. Offsetting this, it had CN¥903.5m in cash and CN¥2.48b in receivables that were due within 12 months. So its liabilities total CN¥1.90b more than the combination of its cash and short-term receivables.

Of course, Guangdong Create Century Intelligent Equipment Group has a market capitalization of CN¥12.3b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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).

Guangdong Create Century Intelligent Equipment Group's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 6.3 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Guangdong Create Century Intelligent Equipment Group made a loss at the EBIT level, last year, but improved that to positive EBIT of CN¥177m in the last twelve months. 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 Guangdong Create Century Intelligent Equipment Group 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Guangdong Create Century Intelligent Equipment Group's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Guangdong Create Century Intelligent Equipment Group's interest cover was a real positive on this analysis, as was its level of total liabilities. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. Looking at all this data makes us feel a little cautious about Guangdong Create Century Intelligent Equipment Group's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more 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. For example - Guangdong Create Century Intelligent Equipment Group has 1 warning sign 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.