These 4 Measures Indicate That GSP Automotive Group WenzhouLtd (SHSE:605088) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, GSP Automotive Group Wenzhou Co.,Ltd. (SHSE:605088) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for GSP Automotive Group WenzhouLtd

What Is GSP Automotive Group WenzhouLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2024 GSP Automotive Group WenzhouLtd had debt of CN¥1.28b, up from CN¥730.9m in one year. But it also has CN¥1.98b in cash to offset that, meaning it has CN¥694.0m net cash.

How Healthy Is GSP Automotive Group WenzhouLtd's Balance Sheet?

The latest balance sheet data shows that GSP Automotive Group WenzhouLtd had liabilities of CN¥2.54b due within a year, and liabilities of CN¥577.4m falling due after that. Offsetting this, it had CN¥1.98b in cash and CN¥1.29b in receivables that were due within 12 months. So it actually has CN¥149.3m more liquid assets than total liabilities.

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

And we also note warmly that GSP Automotive Group WenzhouLtd grew its EBIT by 17% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if GSP Automotive Group WenzhouLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. GSP Automotive Group WenzhouLtd 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, GSP Automotive Group WenzhouLtd recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case GSP Automotive Group WenzhouLtd has CN¥694.0m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 17% over the last year. So we don't have any problem with GSP Automotive Group WenzhouLtd's use of debt. 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 instance, we've identified 2 warning signs for GSP Automotive Group WenzhouLtd (1 shouldn't be ignored) you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.