Is Chacha Food Company (SZSE:002557) Using Too Much 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Chacha Food Company, Limited (SZSE:002557) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Chacha Food Company

What Is Chacha Food Company's Net Debt?

As you can see below, at the end of March 2024, Chacha Food Company had CN¥2.29b of debt, up from CN¥1.70b a year ago. Click the image for more detail. However, it does have CN¥5.75b in cash offsetting this, leading to net cash of CN¥3.46b.

How Strong Is Chacha Food Company's Balance Sheet?

The latest balance sheet data shows that Chacha Food Company had liabilities of CN¥2.14b due within a year, and liabilities of CN¥1.55b falling due after that. On the other hand, it had cash of CN¥5.75b and CN¥242.0m worth of receivables due within a year. So it actually has CN¥2.31b more liquid assets than total liabilities.

This surplus suggests that Chacha Food Company is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Chacha Food Company boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Chacha Food Company saw its EBIT decline by 7.1% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chacha Food Company's ability to maintain a healthy balance sheet going forward. 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 Chacha Food Company 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. Happily for any shareholders, Chacha Food Company actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Chacha Food Company has CN¥3.46b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 109% of that EBIT to free cash flow, bringing in CN¥1.0b. So we don't think Chacha Food Company's use of debt is risky. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Chacha Food Company's dividend history, without delay!

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.

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