Here's Why Guangdong Shunkong DevelopmentLtd (SZSE:003039) Can Manage Its Debt Responsibly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Guangdong Shunkong Development Co.,Ltd. (SZSE:003039) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Guangdong Shunkong DevelopmentLtd

What Is Guangdong Shunkong DevelopmentLtd's Debt?

As you can see below, Guangdong Shunkong DevelopmentLtd had CN¥619.6m of debt at September 2023, down from CN¥733.9m a year prior. However, its balance sheet shows it holds CN¥937.3m in cash, so it actually has CN¥317.7m net cash.

How Healthy Is Guangdong Shunkong DevelopmentLtd's Balance Sheet?

According to the last reported balance sheet, Guangdong Shunkong DevelopmentLtd had liabilities of CN¥993.0m due within 12 months, and liabilities of CN¥519.2m due beyond 12 months. Offsetting this, it had CN¥937.3m in cash and CN¥308.3m in receivables that were due within 12 months. So its liabilities total CN¥266.5m more than the combination of its cash and short-term receivables.

Of course, Guangdong Shunkong DevelopmentLtd has a market capitalization of CN¥8.26b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Guangdong Shunkong DevelopmentLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Guangdong Shunkong DevelopmentLtd saw its EBIT decline by 8.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Guangdong Shunkong DevelopmentLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Guangdong Shunkong DevelopmentLtd 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. In the last three years, Guangdong Shunkong DevelopmentLtd's free cash flow amounted to 45% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Guangdong Shunkong DevelopmentLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥317.7m. So we are not troubled with Guangdong Shunkong DevelopmentLtd'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. Case in point: We've spotted 1 warning sign for Guangdong Shunkong DevelopmentLtd you should be aware of.

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.

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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.