Does Guangdong TCL Smart Home Appliances (SZSE:002668) Have A Healthy Balance Sheet?

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.' 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 Guangdong TCL Smart Home Appliances Co., Ltd. (SZSE:002668) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Guangdong TCL Smart Home Appliances

How Much Debt Does Guangdong TCL Smart Home Appliances Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Guangdong TCL Smart Home Appliances had debt of CN¥1.02b, up from CN¥300.8m in one year. However, it does have CN¥3.98b in cash offsetting this, leading to net cash of CN¥2.96b.

How Healthy Is Guangdong TCL Smart Home Appliances' Balance Sheet?

The latest balance sheet data shows that Guangdong TCL Smart Home Appliances had liabilities of CN¥10.5b due within a year, and liabilities of CN¥394.7m falling due after that. On the other hand, it had cash of CN¥3.98b and CN¥4.83b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥2.09b.

Of course, Guangdong TCL Smart Home Appliances has a market capitalization of CN¥14.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Guangdong TCL Smart Home Appliances also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Guangdong TCL Smart Home Appliances grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. 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 Guangdong TCL Smart Home Appliances'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Guangdong TCL Smart Home Appliances 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. Over the most recent three years, Guangdong TCL Smart Home Appliances recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Guangdong TCL Smart Home Appliances does have more liabilities than liquid assets, it also has net cash of CN¥2.96b. And it impressed us with free cash flow of CN¥1.4b, being 79% of its EBIT. So is Guangdong TCL Smart Home Appliances's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Guangdong TCL Smart Home Appliances, you may well want to click here to check an interactive graph of its earnings per share history.

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.