Does Shanghai Kinlita Chemical (SZSE:300225) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Shanghai Kinlita Chemical Co., Ltd. (SZSE:300225) makes use of debt. But the real question is whether this debt is making the company risky.

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Shanghai Kinlita Chemical

What Is Shanghai Kinlita Chemical's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai Kinlita Chemical had CN¥154.8m of debt, an increase on CN¥96.5m, over one year. However, it does have CN¥117.6m in cash offsetting this, leading to net debt of about CN¥37.1m.

How Healthy Is Shanghai Kinlita Chemical's Balance Sheet?

We can see from the most recent balance sheet that Shanghai Kinlita Chemical had liabilities of CN¥477.7m falling due within a year, and liabilities of CN¥30.4m due beyond that. On the other hand, it had cash of CN¥117.6m and CN¥435.4m worth of receivables due within a year. So it actually has CN¥44.9m more liquid assets than total liabilities.

This state of affairs indicates that Shanghai Kinlita Chemical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥3.94b company is struggling for cash, we still think it's worth monitoring its balance sheet. Carrying virtually no net debt, Shanghai Kinlita Chemical has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shanghai Kinlita Chemical has a low net debt to EBITDA ratio of only 0.57. And its EBIT easily covers its interest expense, being 25.6 times the size. So we're pretty relaxed about its super-conservative use of debt. Although Shanghai Kinlita Chemical made a loss at the EBIT level, last year, it was also good to see that it generated CN¥33m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shanghai Kinlita Chemical will need earnings to service that debt. 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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Shanghai Kinlita Chemical actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Shanghai Kinlita Chemical's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Shanghai Kinlita Chemical's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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 - Shanghai Kinlita Chemical has 1 warning sign we think you should be aware of.

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.