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. As with many other companies GuangZhou Wahlap Technology Corporation Limited (SZSE:301011) 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is GuangZhou Wahlap Technology's Debt?

You can click the graphic below for the historical numbers, but it shows that GuangZhou Wahlap Technology had CN¥84.2m of debt in September 2024, down from CN¥121.4m, one year before. However, it does have CN¥180.7m in cash offsetting this, leading to net cash of CN¥96.6m.

How Healthy Is GuangZhou Wahlap Technology's Balance Sheet?

We can see from the most recent balance sheet that GuangZhou Wahlap Technology had liabilities of CN¥480.2m falling due within a year, and liabilities of CN¥91.8m due beyond that. On the other hand, it had cash of CN¥180.7m and CN¥294.1m worth of receivables due within a year. So its liabilities total CN¥97.2m more than the combination of its cash and short-term receivables.

Of course, GuangZhou Wahlap Technology has a market capitalization of CN¥4.15b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, GuangZhou Wahlap Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, GuangZhou Wahlap Technology grew its EBIT by 442% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is GuangZhou Wahlap Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. GuangZhou Wahlap Technology 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. Over the last three years, GuangZhou Wahlap Technology actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

We could understand if investors are concerned about GuangZhou Wahlap Technology's liabilities, but we can be reassured by the fact it has has net cash of CN¥96.6m. The cherry on top was that in converted 131% of that EBIT to free cash flow, bringing in CN¥165m. So we don't think GuangZhou Wahlap Technology's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example GuangZhou Wahlap Technology has 3 warning signs (and 2 which can't be ignored) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.