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.' 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. We note that Guangzhou Restaurant Group Company Limited (SHSE:603043) does have debt on its balance sheet. 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 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, 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 Guangzhou Restaurant Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Guangzhou Restaurant Group had CN¥839.5m of debt, an increase on CN¥722.8m, over one year. However, it does have CN¥1.97b in cash offsetting this, leading to net cash of CN¥1.13b.

A Look At Guangzhou Restaurant Group's Liabilities

According to the last reported balance sheet, Guangzhou Restaurant Group had liabilities of CN¥2.57b due within 12 months, and liabilities of CN¥913.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.97b as well as receivables valued at CN¥377.0m due within 12 months. So its liabilities total CN¥1.14b more than the combination of its cash and short-term receivables.

Given Guangzhou Restaurant Group has a market capitalization of CN¥10.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Guangzhou Restaurant Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Guangzhou Restaurant Group saw its EBIT drop by 2.9% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Guangzhou Restaurant Group 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangzhou Restaurant Group 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, Guangzhou Restaurant Group recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Guangzhou Restaurant Group does have more liabilities than liquid assets, it also has net cash of CN¥1.13b. And it impressed us with free cash flow of CN¥601m, being 66% of its EBIT. So we don't have any problem with Guangzhou Restaurant Group's use of debt. 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. To that end, you should be aware of the 1 warning sign we've spotted with Guangzhou Restaurant Group .

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.