Zhengzhou Coal Industry & Electric Power (SHSE:600121) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Zhengzhou Coal Industry & Electric Power Co., Ltd. (SHSE:600121) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zhengzhou Coal Industry & Electric Power

What Is Zhengzhou Coal Industry & Electric Power's Net Debt?

As you can see below, at the end of September 2024, Zhengzhou Coal Industry & Electric Power had CN¥2.88b of debt, up from CN¥2.49b a year ago. Click the image for more detail. But on the other hand it also has CN¥3.34b in cash, leading to a CN¥459.0m net cash position.

How Healthy Is Zhengzhou Coal Industry & Electric Power's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Zhengzhou Coal Industry & Electric Power had liabilities of CN¥10.2b due within 12 months and liabilities of CN¥1.03b due beyond that. Offsetting this, it had CN¥3.34b in cash and CN¥1.41b in receivables that were due within 12 months. So it has liabilities totalling CN¥6.48b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of CN¥5.37b, we think shareholders really should watch Zhengzhou Coal Industry & Electric Power's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Zhengzhou Coal Industry & Electric Power boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On the other hand, Zhengzhou Coal Industry & Electric Power saw its EBIT drop by 8.4% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhengzhou Coal Industry & Electric Power'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Zhengzhou Coal Industry & Electric Power may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Zhengzhou Coal Industry & Electric Power recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Zhengzhou Coal Industry & Electric Power's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥459.0m. And it impressed us with free cash flow of -CN¥37m, being 71% of its EBIT. So while Zhengzhou Coal Industry & Electric Power does not have a great balance sheet, it's certainly not too bad. 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 Zhengzhou Coal Industry & Electric Power's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.