Does Shandong HaihuaLtd (SZSE:000822) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shandong Haihua Co.,Ltd (SZSE:000822) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shandong HaihuaLtd

What Is Shandong HaihuaLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Shandong HaihuaLtd had CN¥245.3m of debt, an increase on CN¥130.0m, over one year. But on the other hand it also has CN¥1.58b in cash, leading to a CN¥1.33b net cash position.

How Healthy Is Shandong HaihuaLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shandong HaihuaLtd had liabilities of CN¥2.38b due within 12 months and liabilities of CN¥610.5m due beyond that. Offsetting this, it had CN¥1.58b in cash and CN¥2.64b in receivables that were due within 12 months. So it actually has CN¥1.23b more liquid assets than total liabilities.

This excess liquidity suggests that Shandong HaihuaLtd is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Shandong HaihuaLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Shandong HaihuaLtd has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shandong HaihuaLtd'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 Shandong HaihuaLtd 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. Over the most recent three years, Shandong HaihuaLtd recorded free cash flow worth 51% 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 it is always sensible to investigate a company's debt, in this case Shandong HaihuaLtd has CN¥1.33b in net cash and a decent-looking balance sheet. And we liked the look of last year's 33% year-on-year EBIT growth. So is Shandong HaihuaLtd's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Shandong HaihuaLtd (at least 1 which makes us a bit uncomfortable) , 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.