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 can see that Guangzhou Sie Consulting Co., Ltd. (SZSE:300687) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangzhou Sie Consulting's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Guangzhou Sie Consulting had CN¥447.9m of debt, an increase on CN¥343.8m, over one year. But it also has CN¥666.4m in cash to offset that, meaning it has CN¥218.6m net cash.

A Look At Guangzhou Sie Consulting's Liabilities

According to the last reported balance sheet, Guangzhou Sie Consulting had liabilities of CN¥510.8m due within 12 months, and liabilities of CN¥332.4m due beyond 12 months. On the other hand, it had cash of CN¥666.4m and CN¥1.10b worth of receivables due within a year. So it can boast CN¥920.4m more liquid assets than total liabilities.

It's good to see that Guangzhou Sie Consulting has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Guangzhou Sie Consulting has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Guangzhou Sie Consulting grew its EBIT by 10% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guangzhou Sie Consulting 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangzhou Sie Consulting has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Guangzhou Sie Consulting recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangzhou Sie Consulting has net cash of CN¥218.6m, as well as more liquid assets than liabilities. And it also grew its EBIT by 10% over the last year. So we are not troubled with Guangzhou Sie Consulting's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with Guangzhou Sie Consulting .

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com