Is Qingdao Gaoce Technology (SHSE:688556) A Risky Investment?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Qingdao Gaoce Technology Co., Ltd (SHSE:688556) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Qingdao Gaoce Technology

What Is Qingdao Gaoce Technology's Net Debt?

As you can see below, at the end of September 2024, Qingdao Gaoce Technology had CN¥524.7m of debt, up from CN¥384.1m a year ago. Click the image for more detail. But on the other hand it also has CN¥975.0m in cash, leading to a CN¥450.3m net cash position.

How Healthy Is Qingdao Gaoce Technology's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Qingdao Gaoce Technology had liabilities of CN¥3.20b due within 12 months and liabilities of CN¥613.2m due beyond that. Offsetting these obligations, it had cash of CN¥975.0m as well as receivables valued at CN¥3.28b due within 12 months. So it actually has CN¥432.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Qingdao Gaoce Technology could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Qingdao Gaoce Technology has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Qingdao Gaoce Technology if management cannot prevent a repeat of the 76% 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 Qingdao Gaoce 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Qingdao Gaoce 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, Qingdao Gaoce 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 Qingdao Gaoce Technology has CN¥450.3m in net cash and a decent-looking balance sheet. So we are not troubled with Qingdao Gaoce Technology's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Qingdao Gaoce Technology (of which 1 can't be ignored!) you should know about.

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.