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. Importantly, Guangzhou Kingmed Diagnostics Group Co., Ltd. (SHSE:603882) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 Guangzhou Kingmed Diagnostics Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Guangzhou Kingmed Diagnostics Group had CN¥444.5m of debt, an increase on CN¥380.4m, over one year. But it also has CN¥2.11b in cash to offset that, meaning it has CN¥1.66b net cash.

How Strong Is Guangzhou Kingmed Diagnostics Group's Balance Sheet?

According to the last reported balance sheet, Guangzhou Kingmed Diagnostics Group had liabilities of CN¥2.65b due within 12 months, and liabilities of CN¥566.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.11b as well as receivables valued at CN¥5.63b due within 12 months. So it actually has CN¥4.52b more liquid assets than total liabilities.

This surplus strongly suggests that Guangzhou Kingmed Diagnostics Group has a rock-solid balance sheet (and the debt is of no concern whatsoever). Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Guangzhou Kingmed Diagnostics Group has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Guangzhou Kingmed Diagnostics Group's load is not too heavy, because its EBIT was down 91% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangzhou Kingmed Diagnostics 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Guangzhou Kingmed Diagnostics 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. Looking at the most recent three years, Guangzhou Kingmed Diagnostics Group recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Kingmed Diagnostics Group has CN¥1.66b in net cash and a decent-looking balance sheet. So we are not troubled with Guangzhou Kingmed Diagnostics Group's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Guangzhou Kingmed Diagnostics 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.