Dalian BIO-CHEM (SHSE:603360) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Dalian BIO-CHEM Company Limited (SHSE:603360) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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, 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dalian BIO-CHEM

How Much Debt Does Dalian BIO-CHEM Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Dalian BIO-CHEM had debt of CN¥155.0m, up from CN¥130.0m in one year. However, its balance sheet shows it holds CN¥418.2m in cash, so it actually has CN¥263.1m net cash.

How Healthy Is Dalian BIO-CHEM's Balance Sheet?

The latest balance sheet data shows that Dalian BIO-CHEM had liabilities of CN¥260.8m due within a year, and liabilities of CN¥27.8m falling due after that. On the other hand, it had cash of CN¥418.2m and CN¥511.2m worth of receivables due within a year. So it can boast CN¥640.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Dalian BIO-CHEM could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Dalian BIO-CHEM has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Dalian BIO-CHEM has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dalian BIO-CHEM'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Dalian BIO-CHEM 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, Dalian BIO-CHEM recorded free cash flow worth 72% 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

While we empathize with investors who find debt concerning, you should keep in mind that Dalian BIO-CHEM has net cash of CN¥263.1m, as well as more liquid assets than liabilities. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in CN¥248m. So we are not troubled with Dalian BIO-CHEM's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Dalian BIO-CHEM you should know about.

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.