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. As with many other companies Yunnan Botanee Bio-Technology Group Co.LTD (SZSE:300957) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Yunnan Botanee Bio-Technology GroupLTD's Debt?

As you can see below, at the end of June 2024, Yunnan Botanee Bio-Technology GroupLTD had CN¥592.5m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has CN¥3.77b in cash, leading to a CN¥3.17b net cash position.

How Strong Is Yunnan Botanee Bio-Technology GroupLTD's Balance Sheet?

The latest balance sheet data shows that Yunnan Botanee Bio-Technology GroupLTD had liabilities of CN¥1.07b due within a year, and liabilities of CN¥554.2m falling due after that. Offsetting these obligations, it had cash of CN¥3.77b as well as receivables valued at CN¥852.6m due within 12 months. So it can boast CN¥3.00b more liquid assets than total liabilities.

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

In fact Yunnan Botanee Bio-Technology GroupLTD's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 Yunnan Botanee Bio-Technology GroupLTD 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Yunnan Botanee Bio-Technology GroupLTD has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Yunnan Botanee Bio-Technology GroupLTD recorded free cash flow of 46% of its EBIT, which is weaker 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 Yunnan Botanee Bio-Technology GroupLTD has CN¥3.17b in net cash and a decent-looking balance sheet. So we don't have any problem with Yunnan Botanee Bio-Technology GroupLTD's use of debt. 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. We've identified 4 warning signs with Yunnan Botanee Bio-Technology GroupLTD (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.