The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies NanJing GOVA Technology Co., Ltd. (SHSE:688539) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

What Is NanJing GOVA Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 NanJing GOVA Technology had CN¥20.0m of debt, an increase on CN¥10.0m, over one year. However, its balance sheet shows it holds CN¥1.04b in cash, so it actually has CN¥1.02b net cash.

How Healthy Is NanJing GOVA Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NanJing GOVA Technology had liabilities of CN¥143.6m due within 12 months and liabilities of CN¥37.2m due beyond that. Offsetting this, it had CN¥1.04b in cash and CN¥428.3m in receivables that were due within 12 months. So it can boast CN¥1.28b more liquid assets than total liabilities.

This surplus suggests that NanJing GOVA Technology is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, NanJing GOVA Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that NanJing GOVA Technology saw its EBIT decline by 8.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine NanJing GOVA Technology's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. While NanJing GOVA 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. During the last three years, NanJing GOVA Technology burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case NanJing GOVA Technology has CN¥1.02b in net cash and a decent-looking balance sheet. So we don't have any problem with NanJing GOVA Technology's use of debt. 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 example, we've discovered 2 warning signs for NanJing GOVA Technology (1 is concerning!) that you should be aware of before investing here.

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.