David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Hualan Biological Engineering Inc. (SZSE:002007) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Hualan Biological Engineering Carry?

The chart below, which you can click on for greater detail, shows that Hualan Biological Engineering had CN¥1.10b in debt in March 2024; about the same as the year before. However, its balance sheet shows it holds CN¥4.32b in cash, so it actually has CN¥3.22b net cash.

How Healthy Is Hualan Biological Engineering's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hualan Biological Engineering had liabilities of CN¥2.46b due within 12 months and liabilities of CN¥100.2m due beyond that. Offsetting these obligations, it had cash of CN¥4.32b as well as receivables valued at CN¥2.27b due within 12 months. So it actually has CN¥4.02b more liquid assets than total liabilities.

This short term liquidity is a sign that Hualan Biological Engineering could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Hualan Biological Engineering has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Hualan Biological Engineering grew its EBIT by 30% over the last twelve months, and that growth will make it easier to handle its debt. 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 Hualan Biological Engineering'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Hualan Biological 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. In the last three years, Hualan Biological Engineering's free cash flow amounted to 36% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While it is always sensible to investigate a company's debt, in this case Hualan Biological Engineering has CN¥3.22b in net cash and a decent-looking balance sheet. And we liked the look of last year's 30% year-on-year EBIT growth. So we don't think Hualan Biological Engineering's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for Hualan Biological Engineering you should be aware of.

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.

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