Is Jiangsu Huachang Chemical (SZSE:002274) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Jiangsu Huachang Chemical Co., Ltd (SZSE:002274) 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Jiangsu Huachang Chemical

How Much Debt Does Jiangsu Huachang Chemical Carry?

You can click the graphic below for the historical numbers, but it shows that Jiangsu Huachang Chemical had CN¥130.2m of debt in June 2024, down from CN¥640.2m, one year before. But on the other hand it also has CN¥589.7m in cash, leading to a CN¥459.5m net cash position.

How Strong Is Jiangsu Huachang Chemical's Balance Sheet?

According to the last reported balance sheet, Jiangsu Huachang Chemical had liabilities of CN¥2.18b due within 12 months, and liabilities of CN¥6.14m due beyond 12 months. Offsetting these obligations, it had cash of CN¥589.7m as well as receivables valued at CN¥1.66b due within 12 months. So it can boast CN¥57.3m more liquid assets than total liabilities.

Having regard to Jiangsu Huachang Chemical's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥6.85b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Jiangsu Huachang Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Jiangsu Huachang Chemical grew its EBIT by 67% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Jiangsu Huachang Chemical'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. Jiangsu Huachang Chemical 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. Over the most recent three years, Jiangsu Huachang Chemical recorded free cash flow worth 68% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Jiangsu Huachang Chemical has CN¥459.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 67% year-on-year EBIT growth. So we don't think Jiangsu Huachang Chemical's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Jiangsu Huachang Chemical .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.