Here's Why Hunan Aihua Group (SHSE:603989) Can Manage Its Debt Responsibly

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.' 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 Hunan Aihua Group Co., Ltd (SHSE:603989) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hunan Aihua Group

What Is Hunan Aihua Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Hunan Aihua Group had CN¥329.0m of debt in September 2024, down from CN¥683.4m, one year before. But it also has CN¥1.13b in cash to offset that, meaning it has CN¥804.9m net cash.

How Strong Is Hunan Aihua Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hunan Aihua Group had liabilities of CN¥1.96b due within 12 months and liabilities of CN¥125.9m due beyond that. On the other hand, it had cash of CN¥1.13b and CN¥1.83b worth of receivables due within a year. So it actually has CN¥875.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Hunan Aihua Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hunan Aihua Group has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Hunan Aihua Group's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Hunan Aihua Group'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hunan Aihua Group 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. Over the last three years, Hunan Aihua Group recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hunan Aihua Group has CN¥804.9m in net cash and a decent-looking balance sheet. So we don't have any problem with Hunan Aihua Group's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Hunan Aihua Group you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.