Is GCL System Integration Technology (SZSE:002506) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 GCL System Integration Technology Co., Ltd. (SZSE:002506) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 GCL System Integration Technology

What Is GCL System Integration Technology's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 GCL System Integration Technology had debt of CN¥2.81b, up from CN¥1.80b in one year. But it also has CN¥6.22b in cash to offset that, meaning it has CN¥3.41b net cash.

A Look At GCL System Integration Technology's Liabilities

We can see from the most recent balance sheet that GCL System Integration Technology had liabilities of CN¥13.2b falling due within a year, and liabilities of CN¥4.88b due beyond that. Offsetting these obligations, it had cash of CN¥6.22b as well as receivables valued at CN¥2.77b due within 12 months. So its liabilities total CN¥9.10b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥10.7b, so it does suggest shareholders should keep an eye on GCL System Integration Technology's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. While it does have liabilities worth noting, GCL System Integration Technology also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that GCL System Integration Technology grew its EBIT by 398% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is GCL System Integration Technology's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While GCL System Integration 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 last two years, GCL System Integration Technology saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

Although GCL System Integration Technology's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥3.41b. And it impressed us with its EBIT growth of 398% over the last year. So although we see some areas for improvement, we're not too worried about GCL System Integration Technology's balance sheet. 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. To that end, you should be aware of the 1 warning sign we've spotted with GCL System Integration Technology .

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.