Does Shandong Weifang Rainbow Chemical (SZSE:301035) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Shandong Weifang Rainbow Chemical Co., Ltd (SZSE:301035) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. 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.

How Much Debt Does Shandong Weifang Rainbow Chemical Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shandong Weifang Rainbow Chemical had CN¥3.32b of debt, an increase on CN¥1.78b, over one year. But it also has CN¥3.91b in cash to offset that, meaning it has CN¥590.0m net cash.

A Look At Shandong Weifang Rainbow Chemical's Liabilities

The latest balance sheet data shows that Shandong Weifang Rainbow Chemical had liabilities of CN¥8.73b due within a year, and liabilities of CN¥420.8m falling due after that. On the other hand, it had cash of CN¥3.91b and CN¥4.96b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥283.4m.

Having regard to Shandong Weifang Rainbow Chemical's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the CN¥16.4b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Shandong Weifang Rainbow Chemical boasts net cash, so it's fair to say it does not have a heavy debt load!

See our latest analysis for Shandong Weifang Rainbow Chemical

But the bad news is that Shandong Weifang Rainbow Chemical has seen its EBIT plunge 18% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shandong Weifang Rainbow Chemical's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Shandong Weifang Rainbow 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. Over the last three years, Shandong Weifang Rainbow Chemical saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

We could understand if investors are concerned about Shandong Weifang Rainbow Chemical's liabilities, but we can be reassured by the fact it has has net cash of CN¥590.0m. So although we see some areas for improvement, we're not too worried about Shandong Weifang Rainbow Chemical's balance sheet. 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 3 warning signs with Shandong Weifang Rainbow Chemical (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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.