Here's Why Sichuan Lutianhua Company Limited By Shares (SZSE:000912) Can Manage Its Debt Responsibly

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 Sichuan Lutianhua Company Limited By Shares (SZSE:000912) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sichuan Lutianhua Company Limited By Shares

What Is Sichuan Lutianhua Company Limited By Shares's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Sichuan Lutianhua Company Limited By Shares had CN¥566.2m of debt in September 2023, down from CN¥879.5m, one year before. However, its balance sheet shows it holds CN¥4.20b in cash, so it actually has CN¥3.63b net cash.

How Healthy Is Sichuan Lutianhua Company Limited By Shares' Balance Sheet?

We can see from the most recent balance sheet that Sichuan Lutianhua Company Limited By Shares had liabilities of CN¥3.21b falling due within a year, and liabilities of CN¥705.1m due beyond that. Offsetting this, it had CN¥4.20b in cash and CN¥127.1m in receivables that were due within 12 months. So it can boast CN¥410.3m more liquid assets than total liabilities.

This surplus suggests that Sichuan Lutianhua Company Limited By Shares has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sichuan Lutianhua Company Limited By Shares 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 Sichuan Lutianhua Company Limited By Shares if management cannot prevent a repeat of the 57% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Sichuan Lutianhua Company Limited By Shares'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sichuan Lutianhua Company Limited By Shares 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. Happily for any shareholders, Sichuan Lutianhua Company Limited By Shares actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sichuan Lutianhua Company Limited By Shares has net cash of CN¥3.63b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥197m, being 120% of its EBIT. So we don't have any problem with Sichuan Lutianhua Company Limited By Shares's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Sichuan Lutianhua Company Limited By Shares, you may well want to click here to check an interactive graph of its earnings per share history.

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.