Huafon ChemicalLtd (SZSE:002064) Could Easily Take On More Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Huafon Chemical Co.,Ltd (SZSE:002064) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Huafon ChemicalLtd

What Is Huafon ChemicalLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Huafon ChemicalLtd had debt of CN¥4.06b at the end of June 2024, a reduction from CN¥7.67b over a year. But it also has CN¥10.2b in cash to offset that, meaning it has CN¥6.12b net cash.

A Look At Huafon ChemicalLtd's Liabilities

The latest balance sheet data shows that Huafon ChemicalLtd had liabilities of CN¥10.2b due within a year, and liabilities of CN¥1.62b falling due after that. Offsetting these obligations, it had cash of CN¥10.2b as well as receivables valued at CN¥6.88b due within 12 months. So it actually has CN¥5.18b more liquid assets than total liabilities.

This surplus suggests that Huafon ChemicalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Huafon ChemicalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Huafon ChemicalLtd grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Huafon ChemicalLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Huafon ChemicalLtd 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. In the last three years, Huafon ChemicalLtd's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huafon ChemicalLtd has CN¥6.12b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 61% over the last year. So we don't think Huafon ChemicalLtd's use of debt is risky. 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 Huafon ChemicalLtd 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.