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. As with many other companies Dalian BIO-CHEM Company Limited (SHSE:603360) makes use of 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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Dalian BIO-CHEM

What Is Dalian BIO-CHEM's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Dalian BIO-CHEM had debt of CN¥205.1m, up from CN¥130.0m in one year. But it also has CN¥454.6m in cash to offset that, meaning it has CN¥249.6m net cash.

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

According to the last reported balance sheet, Dalian BIO-CHEM had liabilities of CN¥304.9m due within 12 months, and liabilities of CN¥30.5m due beyond 12 months. Offsetting these obligations, it had cash of CN¥454.6m as well as receivables valued at CN¥454.8m due within 12 months. So it can boast CN¥574.0m 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. Succinctly put, Dalian BIO-CHEM boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Dalian BIO-CHEM has seen its EBIT plunge 16% 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 ultimately the future profitability of the business will decide if Dalian BIO-CHEM can strengthen its balance sheet over time. 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 59% 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¥249.6m, as well as more liquid assets than liabilities. So we don't have any problem with Dalian BIO-CHEM's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Dalian BIO-CHEM that you should be aware of.

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.