Here's Why China Golden Classic Group (HKG:8281) 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.' 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. We note that China Golden Classic Group Limited (HKG:8281) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for China Golden Classic Group

What Is China Golden Classic Group's Debt?

As you can see below, China Golden Classic Group had CN¥15.0m of debt, at December 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds CN¥77.4m in cash, so it actually has CN¥62.4m net cash.

A Look At China Golden Classic Group's Liabilities

Zooming in on the latest balance sheet data, we can see that China Golden Classic Group had liabilities of CN¥101.2m due within 12 months and liabilities of CN¥2.71m due beyond that. Offsetting this, it had CN¥77.4m in cash and CN¥35.0m in receivables that were due within 12 months. So it can boast CN¥8.52m more liquid assets than total liabilities.

This surplus suggests that China Golden Classic Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that China Golden Classic Group has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for China Golden Classic Group if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is China Golden Classic Group'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. China Golden Classic Group 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, China Golden Classic Group generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Golden Classic Group has CN¥62.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in CN¥13m. So we don't have any problem with China Golden Classic Group'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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for China Golden Classic Group you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.