Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Gree Electric Appliances, Inc. of Zhuhai (SZSE:000651) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Gree Electric Appliances of Zhuhai's Net Debt?

As you can see below, Gree Electric Appliances of Zhuhai had CN¥92.8b of debt at March 2024, down from CN¥103.0b a year prior. However, its balance sheet shows it holds CN¥132.9b in cash, so it actually has CN¥40.1b net cash.

How Healthy Is Gree Electric Appliances of Zhuhai's Balance Sheet?

According to the last reported balance sheet, Gree Electric Appliances of Zhuhai had liabilities of CN¥209.0b due within 12 months, and liabilities of CN¥46.4b due beyond 12 months. Offsetting this, it had CN¥132.9b in cash and CN¥35.7b in receivables that were due within 12 months. So it has liabilities totalling CN¥86.8b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Gree Electric Appliances of Zhuhai is worth a massive CN¥222.9b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Gree Electric Appliances of Zhuhai also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Gree Electric Appliances of Zhuhai grew its EBIT at 17% over the last year, further increasing its ability to manage debt. 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 Gree Electric Appliances of Zhuhai'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Gree Electric Appliances of Zhuhai 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. During the last three years, Gree Electric Appliances of Zhuhai generated free cash flow amounting to a very robust 96% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although Gree Electric Appliances of Zhuhai's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥40.1b. And it impressed us with free cash flow of CN¥33b, being 96% of its EBIT. So we don't think Gree Electric Appliances of Zhuhai's use of debt is 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. Case in point: We've spotted 1 warning sign for Gree Electric Appliances of Zhuhai you should be aware of.

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.

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