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. We note that Guangdong Ellington Electronics Technology Co.,Ltd (SHSE:603328) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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.

What Is Guangdong Ellington Electronics TechnologyLtd's Debt?

The chart below, which you can click on for greater detail, shows that Guangdong Ellington Electronics TechnologyLtd had CN¥100.2m in debt in September 2023; about the same as the year before. However, its balance sheet shows it holds CN¥760.5m in cash, so it actually has CN¥660.3m net cash.

How Strong Is Guangdong Ellington Electronics TechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Guangdong Ellington Electronics TechnologyLtd had liabilities of CN¥1.23b due within 12 months and liabilities of CN¥93.2m due beyond that. Offsetting this, it had CN¥760.5m in cash and CN¥1.09b in receivables that were due within 12 months. So it can boast CN¥523.8m more liquid assets than total liabilities.

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

On top of that, Guangdong Ellington Electronics TechnologyLtd grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its debt. 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 Ellington Electronics TechnologyLtd will need earnings to service that debt. 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 Guangdong Ellington Electronics TechnologyLtd 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. During the last three years, Guangdong Ellington Electronics TechnologyLtd produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Guangdong Ellington Electronics TechnologyLtd has net cash of CN¥660.3m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 88% over the last year. So is Guangdong Ellington Electronics TechnologyLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Guangdong Ellington Electronics TechnologyLtd has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.