We Think Guangdong Deerma Technology (SZSE:301332) Can Stay On Top Of Its Debt

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.' 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. As with many other companies Guangdong Deerma Technology Co., Ltd. (SZSE:301332) makes use of debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Guangdong Deerma Technology

What Is Guangdong Deerma Technology's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Guangdong Deerma Technology had CN¥348.3m of debt, an increase on none, over one year. But it also has CN¥1.64b in cash to offset that, meaning it has CN¥1.29b net cash.

A Look At Guangdong Deerma Technology's Liabilities

We can see from the most recent balance sheet that Guangdong Deerma Technology had liabilities of CN¥1.28b falling due within a year, and liabilities of CN¥355.7m due beyond that. On the other hand, it had cash of CN¥1.64b and CN¥551.0m worth of receivables due within a year. So it can boast CN¥556.2m more liquid assets than total liabilities.

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

But the other side of the story is that Guangdong Deerma Technology saw its EBIT decline by 6.5% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong Deerma Technology 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 Deerma Technology recorded free cash flow worth 56% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangdong Deerma Technology has CN¥1.29b in net cash and a decent-looking balance sheet. So we don't have any problem with Guangdong Deerma Technology's use of debt. 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 instance, we've identified 1 warning sign for Guangdong Deerma Technology that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.