Is Beijing Tongrentang (SHSE:600085) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Beijing Tongrentang Co., Ltd (SHSE:600085) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Beijing Tongrentang

How Much Debt Does Beijing Tongrentang Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Beijing Tongrentang had CN¥2.93b of debt, an increase on CN¥2.00b, over one year. But on the other hand it also has CN¥10.9b in cash, leading to a CN¥8.02b net cash position.

A Look At Beijing Tongrentang's Liabilities

Zooming in on the latest balance sheet data, we can see that Beijing Tongrentang had liabilities of CN¥8.41b due within 12 months and liabilities of CN¥2.33b due beyond that. Offsetting these obligations, it had cash of CN¥10.9b as well as receivables valued at CN¥1.94b due within 12 months. So it can boast CN¥2.15b more liquid assets than total liabilities.

This surplus suggests that Beijing Tongrentang has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Beijing Tongrentang has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Beijing Tongrentang's EBIT dived 16%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Beijing Tongrentang'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. While Beijing Tongrentang 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. During the last three years, Beijing Tongrentang produced sturdy free cash flow equating to 57% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Beijing Tongrentang has net cash of CN¥8.02b, as well as more liquid assets than liabilities. So we are not troubled with Beijing Tongrentang's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Beijing Tongrentang is showing 2 warning signs in our investment analysis , and 1 of those 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.