Is Qingdao Gaoce Technology (SHSE:688556) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. 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?

When Is Debt Dangerous?

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. 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. 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.

Check out 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. However, its balance sheet shows it holds CN¥975.0m in cash, so it actually has CN¥450.3m net cash.

How Healthy Is Qingdao Gaoce Technology's Balance Sheet?

The latest balance sheet data shows that Qingdao Gaoce Technology had liabilities of CN¥3.20b due within a year, and liabilities of CN¥613.2m falling due after that. On the other hand, it had cash of CN¥975.0m and CN¥3.28b worth of receivables due within a year. So it actually has CN¥432.6m more liquid assets than total liabilities.

This surplus suggests that Qingdao Gaoce Technology has a conservative balance sheet, and could probably eliminate its debt without much difficulty. 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.

It is just as well that Qingdao Gaoce Technology's load is not too heavy, because its EBIT was down 76% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Qingdao Gaoce Technology 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 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. Over the last three years, Qingdao Gaoce Technology recorded negative free cash flow, in total. 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 don't have any problem with Qingdao Gaoce Technology's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Qingdao Gaoce Technology (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.