Is Hualan Biological Engineering (SZSE:002007) Using Too Much Debt?

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 can see that Hualan Biological Engineering Inc. (SZSE:002007) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hualan Biological Engineering

What Is Hualan Biological Engineering's Debt?

As you can see below, at the end of September 2023, Hualan Biological Engineering had CN¥900.0m of debt, up from CN¥795.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥3.20b in cash, so it actually has CN¥2.30b net cash.

How Healthy Is Hualan Biological Engineering's Balance Sheet?

We can see from the most recent balance sheet that Hualan Biological Engineering had liabilities of CN¥2.22b falling due within a year, and liabilities of CN¥395.4m due beyond that. Offsetting these obligations, it had cash of CN¥3.20b as well as receivables valued at CN¥2.76b due within 12 months. So it actually has CN¥3.35b more liquid assets than total liabilities.

This short term liquidity is a sign that Hualan Biological Engineering could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Hualan Biological Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Hualan Biological Engineering grew its EBIT by 5.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hualan Biological Engineering can strengthen its balance sheet over time. 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. 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 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hualan Biological Engineering has CN¥2.30b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 5.4% in the last twelve months. So we are not troubled with Hualan Biological Engineering's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Hualan Biological Engineering .

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.