These 4 Measures Indicate That Yili Chuanning BiotechnologyLtd (SZSE:301301) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Yili Chuanning Biotechnology Co.,Ltd. (SZSE:301301) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Yili Chuanning BiotechnologyLtd

What Is Yili Chuanning BiotechnologyLtd's Debt?

As you can see below, Yili Chuanning BiotechnologyLtd had CN¥1.77b of debt at June 2024, down from CN¥2.13b a year prior. However, it does have CN¥929.1m in cash offsetting this, leading to net debt of about CN¥837.0m.

How Healthy Is Yili Chuanning BiotechnologyLtd's Balance Sheet?

We can see from the most recent balance sheet that Yili Chuanning BiotechnologyLtd had liabilities of CN¥2.12b falling due within a year, and liabilities of CN¥1.21b due beyond that. Offsetting this, it had CN¥929.1m in cash and CN¥2.07b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥331.6m.

This state of affairs indicates that Yili Chuanning BiotechnologyLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥28.3b company is struggling for cash, we still think it's worth monitoring its balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yili Chuanning BiotechnologyLtd has a low net debt to EBITDA ratio of only 0.39. And its EBIT covers its interest expense a whopping 25.8 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Yili Chuanning BiotechnologyLtd has boosted its EBIT by 93%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Yili Chuanning BiotechnologyLtd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Yili Chuanning BiotechnologyLtd recorded free cash flow worth a fulsome 92% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

The good news is that Yili Chuanning BiotechnologyLtd's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It looks Yili Chuanning BiotechnologyLtd has no trouble standing on its own two feet, and it has no reason to fear its lenders. For investing nerds like us its balance sheet is almost charming. 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. Case in point: We've spotted 1 warning sign for Yili Chuanning BiotechnologyLtd you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.