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.' 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. As with many other companies GuangZhou Wahlap Technology Corporation Limited (SZSE:301011) makes use of debt. But should shareholders be worried about its use of debt?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for GuangZhou Wahlap Technology
As you can see below, GuangZhou Wahlap Technology had CN¥84.2m of debt at September 2024, down from CN¥121.4m a year prior. However, it does have CN¥180.7m in cash offsetting this, leading to net cash of CN¥96.6m.
According to the last reported balance sheet, GuangZhou Wahlap Technology had liabilities of CN¥480.2m due within 12 months, and liabilities of CN¥91.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥180.7m as well as receivables valued at CN¥294.1m due within 12 months. So its liabilities total CN¥97.2m more than the combination of its cash and short-term receivables.
Of course, GuangZhou Wahlap Technology has a market capitalization of CN¥3.75b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, GuangZhou Wahlap Technology boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, GuangZhou Wahlap Technology grew its EBIT by 442% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is GuangZhou Wahlap 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. While GuangZhou Wahlap 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 three years, GuangZhou Wahlap Technology actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about GuangZhou Wahlap Technology's liabilities, but we can be reassured by the fact it has has net cash of CN¥96.6m. And it impressed us with free cash flow of CN¥165m, being 131% of its EBIT. So we don't think GuangZhou Wahlap Technology's use of debt is risky. 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. For example GuangZhou Wahlap Technology has 3 warning signs (and 2 which can't be ignored) we think 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.