Is Suzhou Good-Ark Electronics (SZSE:002079) 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 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 Suzhou Good-Ark Electronics Co., Ltd. (SZSE:002079) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Suzhou Good-Ark Electronics

What Is Suzhou Good-Ark Electronics's Debt?

As you can see below, at the end of September 2024, Suzhou Good-Ark Electronics had CN¥656.5m of debt, up from CN¥183.3m a year ago. Click the image for more detail. But it also has CN¥715.0m in cash to offset that, meaning it has CN¥58.5m net cash.

A Look At Suzhou Good-Ark Electronics' Liabilities

The latest balance sheet data shows that Suzhou Good-Ark Electronics had liabilities of CN¥1.18b due within a year, and liabilities of CN¥206.0m falling due after that. On the other hand, it had cash of CN¥715.0m and CN¥1.49b worth of receivables due within a year. So it actually has CN¥816.0m 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. Simply put, the fact that Suzhou Good-Ark Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Suzhou Good-Ark Electronics's EBIT dived 10%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Suzhou Good-Ark Electronics will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Suzhou Good-Ark Electronics 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. During the last three years, Suzhou Good-Ark Electronics burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Suzhou Good-Ark Electronics has net cash of CN¥58.5m, as well as more liquid assets than liabilities. 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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Suzhou Good-Ark Electronics is showing 2 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.