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 can see that Chengdu Guibao Science & Technology Co.,Ltd. (SZSE:300019) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Chengdu Guibao Science & TechnologyLtd Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Chengdu Guibao Science & TechnologyLtd had debt of CN¥392.6m, up from CN¥155.1m in one year. However, it does have CN¥726.8m in cash offsetting this, leading to net cash of CN¥334.1m.

How Strong Is Chengdu Guibao Science & TechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Chengdu Guibao Science & TechnologyLtd had liabilities of CN¥1.30b falling due within a year, and liabilities of CN¥46.0m due beyond that. On the other hand, it had cash of CN¥726.8m and CN¥1.19b worth of receivables due within a year. So it actually has CN¥570.4m more liquid assets than total liabilities.

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

In fact Chengdu Guibao Science & TechnologyLtd's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Chengdu Guibao Science & TechnologyLtd 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. Chengdu Guibao Science & TechnologyLtd 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, Chengdu Guibao Science & TechnologyLtd recorded free cash flow of 48% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Chengdu Guibao Science & TechnologyLtd has net cash of CN¥334.1m, as well as more liquid assets than liabilities. So we don't have any problem with Chengdu Guibao Science & TechnologyLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Chengdu Guibao Science & TechnologyLtd is showing 1 warning sign in our investment analysis , you should know about...

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.