These 4 Measures Indicate That Hualan Biological Engineering (SZSE:002007) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Hualan Biological Engineering Inc. (SZSE:002007) makes use of debt. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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 chart below, which you can click on for greater detail, shows that Hualan Biological Engineering had CN¥1.10b in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥4.32b in cash, so it actually has CN¥3.22b net cash.

A Look At Hualan Biological Engineering's Liabilities

According to the last reported balance sheet, Hualan Biological Engineering had liabilities of CN¥2.46b due within 12 months, and liabilities of CN¥100.2m due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.32b as well as receivables valued at CN¥2.27b due within 12 months. So it can boast CN¥4.02b 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!

On top of that, Hualan Biological Engineering grew its EBIT by 30% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hualan Biological Engineering can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Hualan Biological Engineering 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. Looking at the most recent three years, Hualan Biological Engineering recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hualan Biological Engineering has net cash of CN¥3.22b, as well as more liquid assets than liabilities. And we liked the look of last year's 30% year-on-year EBIT growth. So is Hualan Biological Engineering's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Hualan Biological Engineering you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.