Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Dalian BIO-CHEM Company Limited (SHSE:603360) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 Dalian BIO-CHEM's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Dalian BIO-CHEM had CN¥155.5m of debt, an increase on CN¥130.0m, over one year. However, its balance sheet shows it holds CN¥418.2m in cash, so it actually has CN¥262.7m net cash.

A Look At Dalian BIO-CHEM's Liabilities

We can see from the most recent balance sheet that Dalian BIO-CHEM had liabilities of CN¥260.8m falling due within a year, and liabilities of CN¥27.8m due beyond that. Offsetting this, it had CN¥418.2m in cash and CN¥511.2m in receivables that were due within 12 months. So it actually has CN¥640.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Dalian BIO-CHEM could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Dalian BIO-CHEM boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Dalian BIO-CHEM's EBIT dived 11%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Dalian BIO-CHEM's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Dalian BIO-CHEM 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. Over the most recent three years, Dalian BIO-CHEM recorded free cash flow worth 71% 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.

Summing Up

While it is always sensible to investigate a company's debt, in this case Dalian BIO-CHEM has CN¥262.7m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of CN¥248m, being 71% of its EBIT. So we don't think Dalian BIO-CHEM's use of debt is risky. 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. For instance, we've identified 1 warning sign for Dalian BIO-CHEM 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.