These 4 Measures Indicate That Sichuan Guoguang Agrochemical (SZSE:002749) Is Using Debt Safely

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Sichuan Guoguang Agrochemical Co., Ltd. (SZSE:002749) 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 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.

View our latest analysis for Sichuan Guoguang Agrochemical

What Is Sichuan Guoguang Agrochemical's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Sichuan Guoguang Agrochemical had debt of CN¥356.2m, up from CN¥311.5m in one year. But it also has CN¥1.27b in cash to offset that, meaning it has CN¥912.4m net cash.

How Strong Is Sichuan Guoguang Agrochemical's Balance Sheet?

We can see from the most recent balance sheet that Sichuan Guoguang Agrochemical had liabilities of CN¥292.6m falling due within a year, and liabilities of CN¥354.1m due beyond that. On the other hand, it had cash of CN¥1.27b and CN¥116.0m worth of receivables due within a year. So it actually has CN¥737.9m more liquid assets than total liabilities.

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

Also good is that Sichuan Guoguang Agrochemical grew its EBIT at 15% over the last year, further increasing its ability to manage 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 Sichuan Guoguang Agrochemical'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 company can only pay off debt with cold hard cash, not accounting profits. While Sichuan Guoguang Agrochemical 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. During the last three years, Sichuan Guoguang Agrochemical generated free cash flow amounting to a very robust 86% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Sichuan Guoguang Agrochemical has CN¥912.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥324m, being 86% of its EBIT. So we don't think Sichuan Guoguang Agrochemical'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. We've identified 1 warning sign with Sichuan Guoguang Agrochemical , and understanding them should be part of your investment process.

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.