Henan Liliang Diamond (SZSE:301071) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Henan Liliang Diamond Co., Ltd. (SZSE:301071) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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.

See our latest analysis for Henan Liliang Diamond

What Is Henan Liliang Diamond's Net Debt?

As you can see below, at the end of September 2024, Henan Liliang Diamond had CN¥599.9m of debt, up from CN¥314.8m a year ago. Click the image for more detail. However, it does have CN¥3.72b in cash offsetting this, leading to net cash of CN¥3.12b.

How Healthy Is Henan Liliang Diamond's Balance Sheet?

According to the last reported balance sheet, Henan Liliang Diamond had liabilities of CN¥825.1m due within 12 months, and liabilities of CN¥374.0m due beyond 12 months. Offsetting these obligations, it had cash of CN¥3.72b as well as receivables valued at CN¥176.9m due within 12 months. So it can boast CN¥2.69b more liquid assets than total liabilities.

This luscious liquidity implies that Henan Liliang Diamond's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Henan Liliang Diamond boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Henan Liliang Diamond's load is not too heavy, because its EBIT was down 35% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Henan Liliang Diamond's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Henan Liliang Diamond 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, Henan Liliang Diamond 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 investigate a company's debt, in this case Henan Liliang Diamond has CN¥3.12b in net cash and a decent-looking balance sheet. So we are not troubled with Henan Liliang Diamond's debt use. 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 1 warning sign with Henan Liliang Diamond , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.