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 note that Gongniu Group Co., Ltd. (SHSE:603195) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Gongniu Group

How Much Debt Does Gongniu Group Carry?

As you can see below, Gongniu Group had CN¥1.03b of debt at September 2023, down from CN¥1.12b a year prior. But on the other hand it also has CN¥13.8b in cash, leading to a CN¥12.8b net cash position.

How Strong Is Gongniu Group's Balance Sheet?

The latest balance sheet data shows that Gongniu Group had liabilities of CN¥5.08b due within a year, and liabilities of CN¥249.7m falling due after that. On the other hand, it had cash of CN¥13.8b and CN¥207.4m worth of receivables due within a year. So it can boast CN¥8.66b more liquid assets than total liabilities.

This short term liquidity is a sign that Gongniu Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Gongniu Group boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Gongniu Group has boosted its EBIT by 43%, thus reducing the spectre of future debt repayments. 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 Group can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. Gongniu 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, Gongniu Group recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Gongniu Group has net cash of CN¥12.8b, as well as more liquid assets than liabilities. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in CN¥4.4b. So is Gongniu 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. 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 1 warning sign for Gongniu Group you should know about.

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.