Is Guangdong Deerma Technology (SZSE:301332) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Guangdong Deerma Technology Co., Ltd. (SZSE:301332) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Guangdong Deerma Technology

How Much Debt Does Guangdong Deerma Technology Carry?

You can click the graphic below for the historical numbers, but it shows that Guangdong Deerma Technology had CN¥13.1m of debt in September 2024, down from CN¥348.3m, one year before. However, it does have CN¥1.56b in cash offsetting this, leading to net cash of CN¥1.55b.

How Strong Is Guangdong Deerma Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong Deerma Technology had liabilities of CN¥1.42b due within 12 months and liabilities of CN¥58.6m due beyond that. Offsetting these obligations, it had cash of CN¥1.56b as well as receivables valued at CN¥511.1m due within 12 months. So it can boast CN¥594.5m more liquid assets than total liabilities.

This short term liquidity is a sign that Guangdong Deerma Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Guangdong Deerma Technology boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Guangdong Deerma Technology if management cannot prevent a repeat of the 62% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Guangdong Deerma Technology'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. Guangdong Deerma Technology 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. Considering the last three years, Guangdong Deerma Technology actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong Deerma Technology has CN¥1.55b in net cash and a decent-looking balance sheet. So although we see some areas for improvement, we're not too worried about Guangdong Deerma Technology's balance sheet. 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. For example - Guangdong Deerma Technology has 3 warning signs we think you should be aware of.

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.