Is China Film (SHSE:600977) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, China Film Co., Ltd. (SHSE:600977) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 China Film

What Is China Film's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 China Film had CN¥520.1m of debt, an increase on CN¥120.8m, over one year. However, it does have CN¥9.52b in cash offsetting this, leading to net cash of CN¥9.00b.

How Strong Is China Film's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that China Film had liabilities of CN¥5.46b due within 12 months and liabilities of CN¥2.10b due beyond that. Offsetting these obligations, it had cash of CN¥9.52b as well as receivables valued at CN¥1.90b due within 12 months. So it can boast CN¥3.85b more liquid assets than total liabilities.

This surplus suggests that China Film is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, China Film boasts net cash, so it's fair to say it does not have a heavy debt load!

Although China Film made a loss at the EBIT level, last year, it was also good to see that it generated CN¥44m in EBIT over the last twelve months. 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 China Film'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. China Film 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 year, China Film actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case China Film has CN¥9.00b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 148% of that EBIT to free cash flow, bringing in CN¥65m. So is China Film's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with China Film (including 1 which is concerning) .

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.