Here's Why Dalian BIO-CHEM (SHSE:603360) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Dalian BIO-CHEM Company Limited (SHSE:603360) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 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 2023 Dalian BIO-CHEM had debt of CN¥130.0m, up from CN¥99.0m in one year. However, its balance sheet shows it holds CN¥501.3m in cash, so it actually has CN¥371.3m net cash.

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

Zooming in on the latest balance sheet data, we can see that Dalian BIO-CHEM had liabilities of CN¥225.6m due within 12 months and liabilities of CN¥47.0m due beyond that. On the other hand, it had cash of CN¥501.3m and CN¥410.6m worth of receivables due within a year. So it actually has CN¥639.4m more liquid assets than total liabilities.

It's good to see that Dalian BIO-CHEM has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Dalian BIO-CHEM boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Dalian BIO-CHEM if management cannot prevent a repeat of the 23% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is Dalian BIO-CHEM'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 company can only pay off debt with cold hard cash, not accounting profits. 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. In the last three years, Dalian BIO-CHEM's free cash flow amounted to 49% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

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¥371.3m, as well as more liquid assets than liabilities. So we are not troubled with Dalian BIO-CHEM's debt use. There's no doubt that we learn most about debt from the balance sheet. 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.

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.