Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies GuoChuang Software Co.,Ltd. (SZSE:300520) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.

What Is GuoChuang SoftwareLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 GuoChuang SoftwareLtd had debt of CN¥1.11b, up from CN¥946.2m in one year. But on the other hand it also has CN¥1.38b in cash, leading to a CN¥271.5m net cash position.

How Strong Is GuoChuang SoftwareLtd's Balance Sheet?

The latest balance sheet data shows that GuoChuang SoftwareLtd had liabilities of CN¥2.42b due within a year, and liabilities of CN¥441.8m falling due after that. Offsetting these obligations, it had cash of CN¥1.38b as well as receivables valued at CN¥1.45b due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that GuoChuang SoftwareLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥4.82b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, GuoChuang SoftwareLtd also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 GuoChuang SoftwareLtd 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.

In the last year GuoChuang SoftwareLtd had a loss before interest and tax, and actually shrunk its revenue by 12%, to CN¥2.3b. We would much prefer see growth.

So How Risky Is GuoChuang SoftwareLtd?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that GuoChuang SoftwareLtd had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥527m and booked a CN¥377m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of CN¥271.5m. That kitty means the company can keep spending for growth for at least two years, at current rates. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for GuoChuang SoftwareLtd that 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.

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