David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Greatoo Intelligent Equipment Inc. (SZSE:002031) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Greatoo Intelligent Equipment Carry?

The chart below, which you can click on for greater detail, shows that Greatoo Intelligent Equipment had CN¥1.26b in debt in March 2024; about the same as the year before. On the flip side, it has CN¥123.6m in cash leading to net debt of about CN¥1.13b.

How Healthy Is Greatoo Intelligent Equipment's Balance Sheet?

According to the last reported balance sheet, Greatoo Intelligent Equipment had liabilities of CN¥1.39b due within 12 months, and liabilities of CN¥510.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥123.6m as well as receivables valued at CN¥594.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥1.18b.

Greatoo Intelligent Equipment has a market capitalization of CN¥5.37b, so it could very likely raise cash to ameliorate 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Greatoo Intelligent Equipment will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Greatoo Intelligent Equipment made a loss at the EBIT level, and saw its revenue drop to CN¥756m, which is a fall of 18%. That's not what we would hope to see.

Caveat Emptor

While Greatoo Intelligent Equipment's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost CN¥32m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled CN¥864m in negative free cash flow over the last twelve months. So in short it's a really risky stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Greatoo Intelligent Equipment has 3 warning signs (and 2 which can't be ignored) we think you should know about.

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.

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