These 4 Measures Indicate That Huafon ChemicalLtd (SZSE:002064) Is Using Debt Reasonably Well

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Huafon Chemical Co.,Ltd (SZSE:002064) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Huafon ChemicalLtd

How Much Debt Does Huafon ChemicalLtd Carry?

As you can see below, Huafon ChemicalLtd had CN¥3.17b of debt at September 2024, down from CN¥6.86b a year prior. However, it does have CN¥8.39b in cash offsetting this, leading to net cash of CN¥5.22b.

A Look At Huafon ChemicalLtd's Liabilities

The latest balance sheet data shows that Huafon ChemicalLtd had liabilities of CN¥7.84b due within a year, and liabilities of CN¥1.38b falling due after that. Offsetting this, it had CN¥8.39b in cash and CN¥6.72b in receivables that were due within 12 months. So it can boast CN¥5.88b 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!

And we also note warmly that Huafon ChemicalLtd grew its EBIT by 16% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Looking at the most recent three years, Huafon ChemicalLtd recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Huafon ChemicalLtd has net cash of CN¥5.22b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 16% over the last year. So we don't think Huafon ChemicalLtd's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Huafon ChemicalLtd that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.