Does Huangshan NovelLtd (SZSE:002014) Have A Healthy Balance Sheet?

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 can see that Huangshan Novel Co.,Ltd (SZSE:002014) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Huangshan NovelLtd

What Is Huangshan NovelLtd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Huangshan NovelLtd had debt of CN¥676.6m, up from CN¥494.1m in one year. But it also has CN¥1.24b in cash to offset that, meaning it has CN¥565.0m net cash.

How Healthy Is Huangshan NovelLtd's Balance Sheet?

The latest balance sheet data shows that Huangshan NovelLtd had liabilities of CN¥1.14b due within a year, and liabilities of CN¥173.2m falling due after that. Offsetting these obligations, it had cash of CN¥1.24b as well as receivables valued at CN¥673.0m due within 12 months. So it can boast CN¥598.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Huangshan NovelLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Huangshan NovelLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Huangshan NovelLtd grew its EBIT at 10% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Huangshan NovelLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Huangshan NovelLtd 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. During the last three years, Huangshan NovelLtd produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. 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 Huangshan NovelLtd has net cash of CN¥565.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥531m, being 71% of its EBIT. So is Huangshan NovelLtd's debt a risk? It doesn't seem so to us. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Huangshan NovelLtd's dividend history, without delay!

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.