Is Shandong Weifang Rainbow Chemical (SZSE:301035) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Shandong Weifang Rainbow Chemical Co., Ltd (SZSE:301035) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Shandong Weifang Rainbow Chemical

How Much Debt Does Shandong Weifang Rainbow Chemical Carry?

The image below, which you can click on for greater detail, shows that at September 2024 Shandong Weifang Rainbow Chemical had debt of CN¥3.32b, up from CN¥1.78b in one year. But it also has CN¥3.91b in cash to offset that, meaning it has CN¥590.0m net cash.

How Healthy Is Shandong Weifang Rainbow Chemical's Balance Sheet?

We can see from the most recent balance sheet that Shandong Weifang Rainbow Chemical had liabilities of CN¥8.73b falling due within a year, and liabilities of CN¥420.8m due beyond that. Offsetting this, it had CN¥3.91b in cash and CN¥4.96b in receivables that were due within 12 months. So its liabilities total CN¥283.4m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Shandong Weifang Rainbow Chemical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥14.4b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shandong Weifang Rainbow Chemical also has more cash than debt, so we're pretty confident it can manage its debt safely.

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. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shandong Weifang Rainbow Chemical has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Shandong Weifang Rainbow Chemical saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shandong Weifang Rainbow Chemical has CN¥590.0m in net cash. So although we see some areas for improvement, we're not too worried about Shandong Weifang Rainbow Chemical's balance sheet. 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. To that end, you should learn about the 3 warning signs we've spotted with Shandong Weifang Rainbow Chemical (including 1 which doesn't sit too well with us) .

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.