Shandong Sinocera Functional Material (SZSE:300285) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, Shandong Sinocera Functional Material Co., Ltd. (SZSE:300285) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Shandong Sinocera Functional Material

What Is Shandong Sinocera Functional Material's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Shandong Sinocera Functional Material had CN¥440.0m of debt, an increase on none, over one year. But on the other hand it also has CN¥709.2m in cash, leading to a CN¥269.3m net cash position.

How Healthy Is Shandong Sinocera Functional Material's Balance Sheet?

We can see from the most recent balance sheet that Shandong Sinocera Functional Material had liabilities of CN¥1.28b falling due within a year, and liabilities of CN¥584.2m due beyond that. Offsetting this, it had CN¥709.2m in cash and CN¥2.06b in receivables that were due within 12 months. So it can boast CN¥907.5m more liquid assets than total liabilities.

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

In fact Shandong Sinocera Functional Material's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Shandong Sinocera Functional Material can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shandong Sinocera Functional Material 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. In the last three years, Shandong Sinocera Functional Material created free cash flow amounting to 3.2% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shandong Sinocera Functional Material has net cash of CN¥269.3m, as well as more liquid assets than liabilities. So we don't have any problem with Shandong Sinocera Functional Material's use of debt. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shandong Sinocera Functional Material's earnings per share history for free.

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.