Here's Why Guoguang ElectricLtd.Chengdu (SHSE:688776) Can Manage Its Debt Responsibly

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Guoguang Electric Co.,Ltd.Chengdu (SHSE:688776) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Guoguang ElectricLtd.Chengdu

What Is Guoguang ElectricLtd.Chengdu's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Guoguang ElectricLtd.Chengdu had debt of CN¥106.2m, up from CN¥30.0m in one year. But it also has CN¥987.3m in cash to offset that, meaning it has CN¥881.1m net cash.

How Strong Is Guoguang ElectricLtd.Chengdu's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guoguang ElectricLtd.Chengdu had liabilities of CN¥409.7m due within 12 months and liabilities of CN¥109.7m due beyond that. On the other hand, it had cash of CN¥987.3m and CN¥881.6m worth of receivables due within a year. So it actually has CN¥1.35b more liquid assets than total liabilities.

It's good to see that Guoguang ElectricLtd.Chengdu has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Guoguang ElectricLtd.Chengdu boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Guoguang ElectricLtd.Chengdu if management cannot prevent a repeat of the 50% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Guoguang ElectricLtd.Chengdu 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Guoguang ElectricLtd.Chengdu 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 last three years, Guoguang ElectricLtd.Chengdu reported free cash flow worth 14% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guoguang ElectricLtd.Chengdu has net cash of CN¥881.1m, as well as more liquid assets than liabilities. So we don't have any problem with Guoguang ElectricLtd.Chengdu's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Guoguang ElectricLtd.Chengdu's earnings per share history for free.

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.

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