Here's Why Guangzhou Zhiguang ElectricLtd (SZSE:002169) Can Afford Some Debt

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. We can see that Guangzhou Zhiguang Electric Co.,Ltd (SZSE:002169) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Guangzhou Zhiguang ElectricLtd

How Much Debt Does Guangzhou Zhiguang ElectricLtd Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Guangzhou Zhiguang ElectricLtd had debt of CN¥2.05b, up from CN¥1.38b in one year. On the flip side, it has CN¥1.02b in cash leading to net debt of about CN¥1.03b.

A Look At Guangzhou Zhiguang ElectricLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangzhou Zhiguang ElectricLtd had liabilities of CN¥3.69b due within 12 months and liabilities of CN¥1.55b due beyond that. Offsetting this, it had CN¥1.02b in cash and CN¥2.04b in receivables that were due within 12 months. So its liabilities total CN¥2.17b more than the combination of its cash and short-term receivables.

Guangzhou Zhiguang ElectricLtd has a market capitalization of CN¥3.68b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Guangzhou Zhiguang ElectricLtd 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.

Over 12 months, Guangzhou Zhiguang ElectricLtd reported revenue of CN¥2.8b, which is a gain of 17%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Guangzhou Zhiguang ElectricLtd produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥32m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through CN¥961m of cash over the last year. So in short it's a really risky stock. 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. We've identified 2 warning signs with Guangzhou Zhiguang ElectricLtd , and understanding them should be part of your investment process.

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.