These 4 Measures Indicate That Dalian BIO-CHEM (SHSE:603360) Is Using Debt Reasonably Well

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Dalian BIO-CHEM Company Limited (SHSE:603360) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View 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 March 2024 Dalian BIO-CHEM had debt of CN¥200.0m, up from CN¥129.0m in one year. However, its balance sheet shows it holds CN¥579.7m in cash, so it actually has CN¥379.7m 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¥321.2m due within 12 months, and liabilities of CN¥31.8m due beyond 12 months. Offsetting these obligations, it had cash of CN¥579.7m as well as receivables valued at CN¥460.6m due within 12 months. So it can boast CN¥687.3m 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 other side of the story is that Dalian BIO-CHEM saw its EBIT decline by 5.7% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dalian BIO-CHEM can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the most recent three years, Dalian BIO-CHEM recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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¥379.7m, as well as more liquid assets than liabilities. So we don't have any problem with Dalian BIO-CHEM's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Dalian BIO-CHEM is showing 1 warning sign in our investment analysis , 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.