Huafon ChemicalLtd (SZSE:002064) Has A Rock Solid Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Huafon Chemical Co.,Ltd (SZSE:002064) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Huafon ChemicalLtd

What Is Huafon ChemicalLtd's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Huafon ChemicalLtd had debt of CN¥5.95b, up from CN¥4.85b in one year. But it also has CN¥11.3b in cash to offset that, meaning it has CN¥5.40b net cash.

How Healthy Is Huafon ChemicalLtd's Balance Sheet?

According to the last reported balance sheet, Huafon ChemicalLtd had liabilities of CN¥10.8b due within 12 months, and liabilities of CN¥1.91b due beyond 12 months. Offsetting this, it had CN¥11.3b in cash and CN¥6.54b in receivables that were due within 12 months. So it can boast CN¥5.18b more liquid assets than total liabilities.

This short term liquidity is a sign that Huafon ChemicalLtd could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Huafon ChemicalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Huafon ChemicalLtd has been able to increase its EBIT by 27% in twelve months, making it easier to pay down debt. 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 Huafon ChemicalLtd 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. While Huafon ChemicalLtd 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. In the last three years, Huafon ChemicalLtd's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Huafon ChemicalLtd has CN¥5.40b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 27% over the last year. So is Huafon ChemicalLtd's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Huafon ChemicalLtd , 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com