Is Guizhou Zhenhua E-chem (SHSE:688707) Using Debt Sensibly?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Guizhou Zhenhua E-chem Inc. (SHSE:688707) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Guizhou Zhenhua E-chem

What Is Guizhou Zhenhua E-chem's Net Debt?

As you can see below, Guizhou Zhenhua E-chem had CN¥2.06b of debt, at June 2024, 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¥2.32b in cash, so it actually has CN¥258.8m net cash.

How Healthy Is Guizhou Zhenhua E-chem's Balance Sheet?

According to the last reported balance sheet, Guizhou Zhenhua E-chem had liabilities of CN¥2.91b due within 12 months, and liabilities of CN¥748.3m due beyond 12 months. Offsetting this, it had CN¥2.32b in cash and CN¥1.43b in receivables that were due within 12 months. So it can boast CN¥93.6m more liquid assets than total liabilities.

This state of affairs indicates that Guizhou Zhenhua E-chem's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥5.96b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Guizhou Zhenhua E-chem has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Guizhou Zhenhua E-chem can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Guizhou Zhenhua E-chem had a loss before interest and tax, and actually shrunk its revenue by 61%, to CN¥4.6b. To be frank that doesn't bode well.

So How Risky Is Guizhou Zhenhua E-chem?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Guizhou Zhenhua E-chem had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of CN¥49m and booked a CN¥65m accounting loss. With only CN¥258.8m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. We've identified 3 warning signs with Guizhou Zhenhua E-chem (at least 1 which is significant) , and understanding them should be part of your investment process.

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.