Zhejiang Dun'an Artificial Environment (SZSE:002011) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Zhejiang Dun'an Artificial Environment Co., Ltd (SZSE:002011) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Zhejiang Dun'an Artificial Environment

How Much Debt Does Zhejiang Dun'an Artificial Environment Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Dun'an Artificial Environment had CN¥1.77b of debt, an increase on CN¥1.37b, over one year. However, it does have CN¥2.70b in cash offsetting this, leading to net cash of CN¥932.7m.

How Healthy Is Zhejiang Dun'an Artificial Environment's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Dun'an Artificial Environment had liabilities of CN¥5.75b falling due within a year, and liabilities of CN¥766.0m due beyond that. Offsetting this, it had CN¥2.70b in cash and CN¥5.13b in receivables that were due within 12 months. So it actually has CN¥1.32b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Dun'an Artificial Environment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Zhejiang Dun'an Artificial Environment boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Zhejiang Dun'an Artificial Environment has increased its EBIT by 9.5% over twelve months, which should ease any concerns about debt repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Zhejiang Dun'an Artificial Environment can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Zhejiang Dun'an Artificial Environment 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, Zhejiang Dun'an Artificial Environment produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Dun'an Artificial Environment has net cash of CN¥932.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥1.2b, being 71% of its EBIT. So is Zhejiang Dun'an Artificial Environment's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Zhejiang Dun'an Artificial Environment's earnings per share history for free.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.