These 4 Measures Indicate That Nanjing COSMOS Chemical (SZSE:300856) Is Using Debt Reasonably Well

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

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Nanjing COSMOS Chemical

What Is Nanjing COSMOS Chemical's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Nanjing COSMOS Chemical had debt of CN¥639.1m, up from CN¥601.6m in one year. However, its balance sheet shows it holds CN¥1.25b in cash, so it actually has CN¥607.9m net cash.

A Look At Nanjing COSMOS Chemical's Liabilities

According to the last reported balance sheet, Nanjing COSMOS Chemical had liabilities of CN¥425.0m due within 12 months, and liabilities of CN¥798.8m due beyond 12 months. On the other hand, it had cash of CN¥1.25b and CN¥434.1m worth of receivables due within a year. So it can boast CN¥457.2m 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 34% over the last twelve months, and that growth will make it easier to handle its debt. 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 Nanjing COSMOS Chemical 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. 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 created free cash flow amounting to 18% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Nanjing COSMOS Chemical has CN¥607.9m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 34% over the last year. So is Nanjing COSMOS Chemical's debt a risk? It doesn't seem so to us. 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 3 warning signs with Nanjing COSMOS Chemical (at least 1 which is potentially serious) , 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.