We Think Guoguang Electric (SZSE:002045) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Guoguang Electric Company Limited (SZSE:002045) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guoguang Electric

What Is Guoguang Electric's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Guoguang Electric had CN¥1.57b of debt, an increase on CN¥1.24b, over one year. However, its balance sheet shows it holds CN¥2.79b in cash, so it actually has CN¥1.23b net cash.

How Healthy Is Guoguang Electric's Balance Sheet?

According to the last reported balance sheet, Guoguang Electric had liabilities of CN¥2.96b due within 12 months, and liabilities of CN¥258.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.79b as well as receivables valued at CN¥1.24b due within 12 months. So it actually has CN¥820.4m more liquid assets than total liabilities.

This surplus suggests that Guoguang Electric has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Guoguang Electric has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Guoguang Electric has boosted its EBIT by 83%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guoguang Electric can strengthen its balance sheet over time. 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. Guoguang Electric 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 two years, Guoguang Electric actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guoguang Electric has CN¥1.23b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 248% of that EBIT to free cash flow, bringing in CN¥553m. So we don't think Guoguang Electric'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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Guoguang Electric you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.