Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Guangdong Goworld Co., Ltd. (SZSE:000823) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Guangdong Goworld's Net Debt?

The image below, which you can click on for greater detail, shows that Guangdong Goworld had debt of CN¥1.49b at the end of September 2024, a reduction from CN¥1.69b over a year. However, its balance sheet shows it holds CN¥1.81b in cash, so it actually has CN¥320.0m net cash.

A Look At Guangdong Goworld's Liabilities

According to the last reported balance sheet, Guangdong Goworld had liabilities of CN¥1.86b due within 12 months, and liabilities of CN¥1.20b due beyond 12 months. On the other hand, it had cash of CN¥1.81b and CN¥1.88b worth of receivables due within a year. So it actually has CN¥630.3m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Goworld could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Guangdong Goworld has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Guangdong Goworld has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangdong Goworld will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangdong Goworld 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 most recent three years, Guangdong Goworld recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong Goworld has CN¥320.0m in net cash and a decent-looking balance sheet. So we are not troubled with Guangdong Goworld'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. Be aware that Guangdong Goworld is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.