Does Henan Jinyuan Hydrogenated Chemicals (HKG:2502) Have A Healthy Balance Sheet?

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.' 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 Henan Jinyuan Hydrogenated Chemicals Co., Ltd. (HKG:2502) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Henan Jinyuan Hydrogenated Chemicals

What Is Henan Jinyuan Hydrogenated Chemicals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Henan Jinyuan Hydrogenated Chemicals had CN¥339.7m of debt, an increase on CN¥241.7m, over one year. But on the other hand it also has CN¥388.2m in cash, leading to a CN¥48.6m net cash position.

A Look At Henan Jinyuan Hydrogenated Chemicals' Liabilities

The latest balance sheet data shows that Henan Jinyuan Hydrogenated Chemicals had liabilities of CN¥418.4m due within a year, and liabilities of CN¥155.7m falling due after that. Offsetting these obligations, it had cash of CN¥388.2m as well as receivables valued at CN¥129.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥56.6m.

Given Henan Jinyuan Hydrogenated Chemicals has a market capitalization of CN¥574.2m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Henan Jinyuan Hydrogenated Chemicals also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Henan Jinyuan Hydrogenated Chemicals's load is not too heavy, because its EBIT was down 69% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Henan Jinyuan Hydrogenated Chemicals's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Henan Jinyuan Hydrogenated Chemicals 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 most recent three years, Henan Jinyuan Hydrogenated Chemicals recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

We could understand if investors are concerned about Henan Jinyuan Hydrogenated Chemicals's liabilities, but we can be reassured by the fact it has has net cash of CN¥48.6m. So we don't have any problem with Henan Jinyuan Hydrogenated Chemicals's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Henan Jinyuan Hydrogenated Chemicals , and understanding them should be part of your investment process.

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.