Here's Why Guangzhou Metro Design & Research Institute (SZSE:003013) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 Guangzhou Metro Design & Research Institute Co., Ltd. (SZSE:003013) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Guangzhou Metro Design & Research Institute

How Much Debt Does Guangzhou Metro Design & Research Institute Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Guangzhou Metro Design & Research Institute had debt of CN¥570.6m, up from CN¥296.0m in one year. But it also has CN¥739.1m in cash to offset that, meaning it has CN¥168.5m net cash.

How Healthy Is Guangzhou Metro Design & Research Institute's Balance Sheet?

According to the last reported balance sheet, Guangzhou Metro Design & Research Institute had liabilities of CN¥3.08b due within 12 months, and liabilities of CN¥33.8m due beyond 12 months. Offsetting this, it had CN¥739.1m in cash and CN¥2.18b in receivables that were due within 12 months. So it has liabilities totalling CN¥190.4m more than its cash and near-term receivables, combined.

Given Guangzhou Metro Design & Research Institute has a market capitalization of CN¥6.34b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Guangzhou Metro Design & Research Institute also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, Guangzhou Metro Design & Research Institute grew its EBIT by 6.3% in the last year, making that debt load look even more manageable. 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 Guangzhou Metro Design & Research Institute can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Guangzhou Metro Design & Research Institute 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. In the last three years, Guangzhou Metro Design & Research Institute basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Guangzhou Metro Design & Research Institute has CN¥168.5m in net cash. On top of that, it increased its EBIT by 6.3% in the last twelve months. So we are not troubled with Guangzhou Metro Design & Research Institute's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for Guangzhou Metro Design & Research Institute (1 is a bit unpleasant) you should be aware of.

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.

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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.