Sichuan Qiaoyuan GasLtd (SZSE:301286) Seems To Use Debt Quite Sensibly

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 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 Sichuan Qiaoyuan Gas Co.,Ltd. (SZSE:301286) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sichuan Qiaoyuan GasLtd

What Is Sichuan Qiaoyuan GasLtd's Net Debt?

The image below, which you can click on for greater detail, shows that Sichuan Qiaoyuan GasLtd had debt of CN¥12.2m at the end of September 2023, a reduction from CN¥125.4m over a year. However, its balance sheet shows it holds CN¥223.3m in cash, so it actually has CN¥211.2m net cash.

How Strong Is Sichuan Qiaoyuan GasLtd's Balance Sheet?

We can see from the most recent balance sheet that Sichuan Qiaoyuan GasLtd had liabilities of CN¥266.6m falling due within a year, and liabilities of CN¥35.6m due beyond that. Offsetting this, it had CN¥223.3m in cash and CN¥244.6m in receivables that were due within 12 months. So it actually has CN¥165.7m more liquid assets than total liabilities.

Having regard to Sichuan Qiaoyuan GasLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥10.8b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Sichuan Qiaoyuan GasLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Sichuan Qiaoyuan GasLtd grew its EBIT by 31% 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 it is future earnings, more than anything, that will determine Sichuan Qiaoyuan GasLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Sichuan Qiaoyuan GasLtd 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, Sichuan Qiaoyuan GasLtd 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 Sichuan Qiaoyuan GasLtd has CN¥211.2m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 31% over the last year. So we don't have any problem with Sichuan Qiaoyuan GasLtd's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Sichuan Qiaoyuan GasLtd , 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.