Is Guizhou Space Appliance (SZSE:002025) Using Too Much Debt?

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.' 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 note that Guizhou Space Appliance Co., LTD (SZSE:002025) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Guizhou Space Appliance

What Is Guizhou Space Appliance's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guizhou Space Appliance had CN¥360.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds CN¥1.94b in cash, so it actually has CN¥1.58b net cash.

A Look At Guizhou Space Appliance's Liabilities

We can see from the most recent balance sheet that Guizhou Space Appliance had liabilities of CN¥3.56b falling due within a year, and liabilities of CN¥400.4m due beyond that. On the other hand, it had cash of CN¥1.94b and CN¥6.50b worth of receivables due within a year. So it can boast CN¥4.49b more liquid assets than total liabilities.

This surplus suggests that Guizhou Space Appliance is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Guizhou Space Appliance boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Guizhou Space Appliance grew its EBIT by 18% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Guizhou Space Appliance's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Guizhou Space Appliance 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, Guizhou Space Appliance reported free cash flow worth 3.9% 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 it is always sensible to investigate a company's debt, in this case Guizhou Space Appliance has CN¥1.58b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 18% over the last year. So we don't think Guizhou Space Appliance's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. 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 Guizhou Space Appliance .

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.