GRG Metrology & Test Group (SZSE:002967) Has A Pretty Healthy Balance Sheet

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 GRG Metrology & Test Group Co., Ltd. (SZSE:002967) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for GRG Metrology & Test Group

How Much Debt Does GRG Metrology & Test Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 GRG Metrology & Test Group had CN¥1.34b of debt, an increase on CN¥1.00b, over one year. However, it also had CN¥1.25b in cash, and so its net debt is CN¥98.4m.

A Look At GRG Metrology & Test Group's Liabilities

According to the last reported balance sheet, GRG Metrology & Test Group had liabilities of CN¥1.50b due within 12 months, and liabilities of CN¥789.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.25b as well as receivables valued at CN¥1.74b due within 12 months. So it actually has CN¥703.7m more liquid assets than total liabilities.

This surplus suggests that GRG Metrology & Test Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. But either way, GRG Metrology & Test Group has virtually no net debt, so it's fair to say it does not have a heavy debt load!

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

GRG Metrology & Test Group's net debt is only 0.19 times its EBITDA. And its EBIT covers its interest expense a whopping 27.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, GRG Metrology & Test Group's EBIT dived 13%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine GRG Metrology & Test Group'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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, GRG Metrology & Test Group 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.

Our View

GRG Metrology & Test Group's interest cover was a real positive on this analysis, as was its net debt to EBITDA. But truth be told its conversion of EBIT to free cash flow had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about GRG Metrology & Test Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - GRG Metrology & Test Group has 1 warning sign we think 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.

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