Is Suzhou Good-Ark Electronics (SZSE:002079) Using Too Much Debt?

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.' 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. We note that Suzhou Good-Ark Electronics Co., Ltd. (SZSE:002079) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Suzhou Good-Ark Electronics

How Much Debt Does Suzhou Good-Ark Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Suzhou Good-Ark Electronics had debt of CN¥183.3m, up from CN¥45.0m in one year. However, it does have CN¥541.2m in cash offsetting this, leading to net cash of CN¥357.8m.

A Look At Suzhou Good-Ark Electronics' Liabilities

We can see from the most recent balance sheet that Suzhou Good-Ark Electronics had liabilities of CN¥578.0m falling due within a year, and liabilities of CN¥94.1m due beyond that. On the other hand, it had cash of CN¥541.2m and CN¥991.0m worth of receivables due within a year. So it actually has CN¥860.1m more liquid assets than total liabilities.

This surplus suggests that Suzhou Good-Ark Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Suzhou Good-Ark Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Suzhou Good-Ark Electronics has seen its EBIT plunge 14% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Suzhou Good-Ark Electronics can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Suzhou Good-Ark Electronics 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 last three years, Suzhou Good-Ark Electronics barely recorded positive free cash flow, in total. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Summing Up

While it is always sensible to investigate a company's debt, in this case Suzhou Good-Ark Electronics has CN¥357.8m in net cash and a decent-looking balance sheet. So we don't have any problem with Suzhou Good-Ark Electronics'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. Be aware that Suzhou Good-Ark Electronics is showing 1 warning sign in our investment analysis , you should know about...

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.