Hualan Biological Engineering (SZSE:002007) Seems To Use Debt Quite Sensibly

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. As with many other companies Hualan Biological Engineering Inc. (SZSE:002007) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. 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.

View our latest analysis for Hualan Biological Engineering

How Much Debt Does Hualan Biological Engineering Carry?

The image below, which you can click on for greater detail, shows that Hualan Biological Engineering had debt of CN¥750.8m at the end of September 2024, a reduction from CN¥900.0m over a year. But on the other hand it also has CN¥2.62b in cash, leading to a CN¥1.87b net cash position.

How Strong Is Hualan Biological Engineering's Balance Sheet?

According to the last reported balance sheet, Hualan Biological Engineering had liabilities of CN¥2.29b due within 12 months, and liabilities of CN¥99.9m due beyond 12 months. Offsetting these obligations, it had cash of CN¥2.62b as well as receivables valued at CN¥2.53b due within 12 months. So it can boast CN¥2.76b more liquid assets than total liabilities.

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

Hualan Biological Engineering's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Hualan Biological Engineering'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 Hualan Biological Engineering 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. Looking at the most recent three years, Hualan Biological Engineering recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hualan Biological Engineering has CN¥1.87b in net cash and a decent-looking balance sheet. So we don't have any problem with Hualan Biological Engineering'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 Hualan Biological Engineering , 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.