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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Guangdong Shenglu Telecommunication Tech. Co., Ltd. (SZSE:002446) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangdong Shenglu Telecommunication Tech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Guangdong Shenglu Telecommunication Tech had CN¥317.1m of debt, an increase on CN¥207.9m, over one year. However, its balance sheet shows it holds CN¥943.1m in cash, so it actually has CN¥626.0m net cash.

How Strong Is Guangdong Shenglu Telecommunication Tech's Balance Sheet?

We can see from the most recent balance sheet that Guangdong Shenglu Telecommunication Tech had liabilities of CN¥810.4m falling due within a year, and liabilities of CN¥222.4m due beyond that. On the other hand, it had cash of CN¥943.1m and CN¥902.5m worth of receivables due within a year. So it can boast CN¥812.9m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Shenglu Telecommunication Tech could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangdong Shenglu Telecommunication Tech boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Guangdong Shenglu Telecommunication Tech's load is not too heavy, because its EBIT was down 76% 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 Guangdong Shenglu Telecommunication Tech 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangdong Shenglu Telecommunication Tech 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, Guangdong Shenglu Telecommunication Tech reported free cash flow worth 19% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Shenglu Telecommunication Tech has net cash of CN¥626.0m, as well as more liquid assets than liabilities. So we are not troubled with Guangdong Shenglu Telecommunication Tech's debt use. Even though Guangdong Shenglu Telecommunication Tech lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.