These 4 Measures Indicate That Wuhan Tianyuan Environmental ProtectionLTD (SZSE:301127) Is Using Debt Reasonably Well

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.' 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 Wuhan Tianyuan Environmental Protection Co.,LTD (SZSE:301127) makes use of debt. 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. If things get really bad, the lenders can take control of the business. 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.

See our latest analysis for Wuhan Tianyuan Environmental ProtectionLTD

How Much Debt Does Wuhan Tianyuan Environmental ProtectionLTD Carry?

As you can see below, at the end of June 2024, Wuhan Tianyuan Environmental ProtectionLTD had CN¥2.08b of debt, up from CN¥554.8m a year ago. Click the image for more detail. However, because it has a cash reserve of CN¥1.52b, its net debt is less, at about CN¥553.1m.

A Look At Wuhan Tianyuan Environmental ProtectionLTD's Liabilities

According to the last reported balance sheet, Wuhan Tianyuan Environmental ProtectionLTD had liabilities of CN¥1.24b due within 12 months, and liabilities of CN¥2.16b due beyond 12 months. Offsetting these obligations, it had cash of CN¥1.52b as well as receivables valued at CN¥1.06b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥818.6m.

Since publicly traded Wuhan Tianyuan Environmental ProtectionLTD shares are worth a total of CN¥6.82b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Wuhan Tianyuan Environmental ProtectionLTD's net debt is only 1.1 times its EBITDA. And its EBIT covers its interest expense a whopping 12.8 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Wuhan Tianyuan Environmental ProtectionLTD has boosted its EBIT by 100%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wuhan Tianyuan Environmental ProtectionLTD'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wuhan Tianyuan Environmental ProtectionLTD saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Happily, Wuhan Tianyuan Environmental ProtectionLTD's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. Looking at all the aforementioned factors together, it strikes us that Wuhan Tianyuan Environmental ProtectionLTD can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Wuhan Tianyuan Environmental ProtectionLTD (including 1 which is a bit unpleasant) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.