Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Qingdao Gaoce Technology Co., Ltd (SHSE:688556) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Qingdao Gaoce Technology's Net Debt?

As you can see below, at the end of June 2024, Qingdao Gaoce Technology had CN¥488.4m of debt, up from CN¥353.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.54b in cash, so it actually has CN¥1.05b net cash.

How Strong Is Qingdao Gaoce Technology's Balance Sheet?

According to the last reported balance sheet, Qingdao Gaoce Technology had liabilities of CN¥3.67b due within 12 months, and liabilities of CN¥645.9m due beyond 12 months. Offsetting this, it had CN¥1.54b in cash and CN¥3.40b in receivables that were due within 12 months. So it can boast CN¥631.8m more liquid assets than total liabilities.

This surplus suggests that Qingdao Gaoce Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Qingdao Gaoce Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Qingdao Gaoce Technology if management cannot prevent a repeat of the 22% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Qingdao Gaoce Technology 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 Qingdao Gaoce Technology 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. In the last three years, Qingdao Gaoce Technology created free cash flow amounting to 9.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Qingdao Gaoce Technology has CN¥1.05b in net cash and a decent-looking balance sheet. So we are not troubled with Qingdao Gaoce Technology's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Qingdao Gaoce Technology (at least 1 which is significant) , and understanding them should be part of your investment process.

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.