Does Nanjing COSMOS Chemical (SZSE:300856) 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.' 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 Nanjing COSMOS Chemical Co., Ltd. (SZSE:300856) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 Nanjing COSMOS Chemical

What Is Nanjing COSMOS Chemical's Net Debt?

As you can see below, at the end of March 2024, Nanjing COSMOS Chemical had CN¥631.3m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥1.23b in cash, so it actually has CN¥603.6m net cash.

How Healthy Is Nanjing COSMOS Chemical's Balance Sheet?

According to the last reported balance sheet, Nanjing COSMOS Chemical had liabilities of CN¥453.0m due within 12 months, and liabilities of CN¥794.1m due beyond 12 months. Offsetting this, it had CN¥1.23b in cash and CN¥558.1m in receivables that were due within 12 months. So it can boast CN¥545.9m more liquid assets than total liabilities.

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

On top of that, Nanjing COSMOS Chemical grew its EBIT by 57% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Nanjing COSMOS Chemical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Nanjing COSMOS 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. In the last three years, Nanjing COSMOS Chemical basically broke even on a free cash flow basis. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nanjing COSMOS Chemical has CN¥603.6m in net cash and a decent-looking balance sheet. And we liked the look of last year's 57% year-on-year EBIT growth. So we don't think Nanjing COSMOS 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. We've identified 2 warning signs with Nanjing COSMOS Chemical (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.