Warren Buffett famously said, '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. As with many other companies Yili Chuanning Biotechnology Co.,Ltd. (SZSE:301301) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, 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.

What Is Yili Chuanning BiotechnologyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Yili Chuanning BiotechnologyLtd had CN¥1.41b of debt in September 2024, down from CN¥2.11b, one year before. However, because it has a cash reserve of CN¥624.8m, its net debt is less, at about CN¥787.9m.

How Healthy Is Yili Chuanning BiotechnologyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Yili Chuanning BiotechnologyLtd had liabilities of CN¥2.00b due within 12 months and liabilities of CN¥965.2m due beyond that. Offsetting these obligations, it had cash of CN¥624.8m as well as receivables valued at CN¥2.18b due within 12 months. So its liabilities total CN¥152.9m more than the combination of its cash and short-term receivables.

Having regard to Yili Chuanning BiotechnologyLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥32.2b company is struggling for cash, we still think it's worth monitoring its balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Yili Chuanning BiotechnologyLtd has a low net debt to EBITDA ratio of only 0.36. And its EBIT covers its interest expense a whopping 33.7 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Yili Chuanning BiotechnologyLtd has boosted its EBIT by 68%, thus reducing the spectre of future debt repayments. 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 Yili Chuanning BiotechnologyLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Yili Chuanning BiotechnologyLtd recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Yili Chuanning BiotechnologyLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! It looks Yili Chuanning BiotechnologyLtd has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. 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. Case in point: We've spotted 2 warning signs for Yili Chuanning BiotechnologyLtd you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.