Here's Why Tiande Chemical Holdings (HKG:609) 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.' 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 Tiande Chemical Holdings Limited (HKG:609) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Tiande Chemical Holdings

What Is Tiande Chemical Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that Tiande Chemical Holdings had debt of CN¥159.9m at the end of December 2021, a reduction from CN¥217.4m over a year. However, its balance sheet shows it holds CN¥226.3m in cash, so it actually has CN¥66.4m net cash.

A Look At Tiande Chemical Holdings' Liabilities

We can see from the most recent balance sheet that Tiande Chemical Holdings had liabilities of CN¥543.5m falling due within a year, and liabilities of CN¥18.4m due beyond that. Offsetting these obligations, it had cash of CN¥226.3m as well as receivables valued at CN¥512.7m due within 12 months. So it actually has CN¥177.1m more liquid assets than total liabilities.

This surplus suggests that Tiande Chemical Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Tiande Chemical Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Tiande Chemical Holdings grew its EBIT by 1,693% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. 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 Tiande Chemical Holdings 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 company can only pay off debt with cold hard cash, not accounting profits. Tiande Chemical Holdings 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. Considering the last three years, Tiande Chemical Holdings actually recorded a cash outflow, overall. 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 Tiande Chemical Holdings has CN¥66.4m in net cash and a decent-looking balance sheet. And we liked the look of last year's 1,693% year-on-year EBIT growth. So we don't think Tiande Chemical Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Tiande Chemical Holdings you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.