We Think China Golden Classic Group (HKG:8281) Can Stay On Top Of Its 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 can see that China Golden Classic Group Limited (HKG:8281) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. 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 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 2021, down from CN¥20.0m a year prior. However, its balance sheet shows it holds CN¥74.8m in cash, so it actually has CN¥59.8m net cash.

How Strong Is China Golden Classic Group's Balance Sheet?

We can see from the most recent balance sheet that China Golden Classic Group had liabilities of CN¥103.7m falling due within a year, and liabilities of CN¥1.25m due beyond that. Offsetting this, it had CN¥74.8m in cash and CN¥48.2m in receivables that were due within 12 months. So it actually has CN¥18.0m 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. Succinctly put, China Golden Classic Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for China Golden Classic Group if management cannot prevent a repeat of the 45% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is China Golden Classic Group's earnings that will influence how the balance sheet holds up in the future. 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. 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. Happily for any shareholders, China Golden Classic Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that China Golden Classic Group has net cash of CN¥59.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in -CN¥9.7m. So we don't have any problem with China Golden Classic Group'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. For instance, we've identified 2 warning signs for China Golden Classic Group that you should be aware of.

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.