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. Importantly, China National Chemical Engineering Co., Ltd (SHSE:601117) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is China National Chemical Engineering's Debt?

The image below, which you can click on for greater detail, shows that China National Chemical Engineering had debt of CN¥9.15b at the end of March 2024, a reduction from CN¥11.1b over a year. However, its balance sheet shows it holds CN¥41.0b in cash, so it actually has CN¥31.9b net cash.

How Healthy Is China National Chemical Engineering's Balance Sheet?

We can see from the most recent balance sheet that China National Chemical Engineering had liabilities of CN¥144.2b falling due within a year, and liabilities of CN¥9.71b due beyond that. On the other hand, it had cash of CN¥41.0b and CN¥97.1b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥15.8b.

This deficit isn't so bad because China National Chemical Engineering is worth CN¥47.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, China National Chemical Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that China National Chemical Engineering grew its EBIT at 14% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine China National Chemical Engineering'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, a company can only pay off debt with cold hard cash, not accounting profits. China National Chemical Engineering 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, China National Chemical Engineering 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

Although China National Chemical Engineering's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥31.9b. On top of that, it increased its EBIT by 14% in the last twelve months. So we don't have any problem with China National Chemical Engineering's use of debt. 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 China National Chemical Engineering you should be aware of.

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.

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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.

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