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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Jiangsu Lihua Animal Husbandry Co., Ltd. (SZSE:300761) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Jiangsu Lihua Animal Husbandry's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Jiangsu Lihua Animal Husbandry had CN¥3.03b of debt, an increase on CN¥1.85b, over one year. On the flip side, it has CN¥1.85b in cash leading to net debt of about CN¥1.19b.

How Strong Is Jiangsu Lihua Animal Husbandry's Balance Sheet?

The latest balance sheet data shows that Jiangsu Lihua Animal Husbandry had liabilities of CN¥5.46b due within a year, and liabilities of CN¥904.0m falling due after that. Offsetting this, it had CN¥1.85b in cash and CN¥214.5m in receivables that were due within 12 months. So its liabilities total CN¥4.30b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Jiangsu Lihua Animal Husbandry has a market capitalization of CN¥15.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. 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 Jiangsu Lihua Animal Husbandry'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.

In the last year Jiangsu Lihua Animal Husbandry wasn't profitable at an EBIT level, but managed to grow its revenue by 17%, to CN¥15b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Jiangsu Lihua Animal Husbandry produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CN¥65m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through CN¥909m of cash over the last year. So suffice it to say we consider the stock very risky. 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. For instance, we've identified 1 warning sign for Jiangsu Lihua Animal Husbandry that you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.