Does Daoming Optics&ChemicalLtd (SZSE:002632) Have A Healthy Balance Sheet?

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. We can see that Daoming Optics&Chemical Co.,Ltd (SZSE:002632) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Daoming Optics&ChemicalLtd

How Much Debt Does Daoming Optics&ChemicalLtd Carry?

The image below, which you can click on for greater detail, shows that Daoming Optics&ChemicalLtd had debt of CN¥250.2m at the end of September 2024, a reduction from CN¥416.8m over a year. But it also has CN¥654.3m in cash to offset that, meaning it has CN¥404.1m net cash.

How Strong Is Daoming Optics&ChemicalLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Daoming Optics&ChemicalLtd had liabilities of CN¥608.3m due within 12 months and liabilities of CN¥27.0m due beyond that. On the other hand, it had cash of CN¥654.3m and CN¥382.3m worth of receivables due within a year. So it actually has CN¥401.4m more liquid assets than total liabilities.

This surplus suggests that Daoming Optics&ChemicalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Daoming Optics&ChemicalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Daoming Optics&ChemicalLtd has boosted its EBIT by 53%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Daoming Optics&ChemicalLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Daoming Optics&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. During the last three years, Daoming Optics&ChemicalLtd generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While it is always sensible to investigate a company's debt, in this case Daoming Optics&ChemicalLtd has CN¥404.1m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in CN¥246m. So is Daoming Optics&ChemicalLtd's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Daoming Optics&ChemicalLtd you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.