Zhejiang Jiahua Energy Chemical IndustryLtd (SHSE:600273) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Zhejiang Jiahua Energy Chemical Industry Co.,Ltd. (SHSE:600273) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Zhejiang Jiahua Energy Chemical IndustryLtd

What Is Zhejiang Jiahua Energy Chemical IndustryLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Zhejiang Jiahua Energy Chemical IndustryLtd had CN¥518.1m of debt, an increase on CN¥450.1m, over one year. But on the other hand it also has CN¥712.3m in cash, leading to a CN¥194.2m net cash position.

How Strong Is Zhejiang Jiahua Energy Chemical IndustryLtd's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Jiahua Energy Chemical IndustryLtd had liabilities of CN¥2.47b falling due within a year, and liabilities of CN¥348.1m due beyond that. Offsetting these obligations, it had cash of CN¥712.3m as well as receivables valued at CN¥1.56b due within 12 months. So it has liabilities totalling CN¥550.7m more than its cash and near-term receivables, combined.

Of course, Zhejiang Jiahua Energy Chemical IndustryLtd has a market capitalization of CN¥11.7b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Zhejiang Jiahua Energy Chemical IndustryLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Zhejiang Jiahua Energy Chemical IndustryLtd has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zhejiang Jiahua Energy Chemical IndustryLtd'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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zhejiang Jiahua Energy Chemical IndustryLtd 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. Looking at the most recent three years, Zhejiang Jiahua Energy Chemical IndustryLtd recorded free cash flow of 46% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Zhejiang Jiahua Energy Chemical IndustryLtd's liabilities, but we can be reassured by the fact it has has net cash of CN¥194.2m. So we are not troubled with Zhejiang Jiahua Energy Chemical IndustryLtd's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Zhejiang Jiahua Energy Chemical IndustryLtd (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

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.

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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.