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.' 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. We note that Jihua Group Corporation Limited (SHSE:601718) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Jihua Group Carry?
The image below, which you can click on for greater detail, shows that Jihua Group had debt of CN¥1.53b at the end of September 2024, a reduction from CN¥2.26b over a year. But on the other hand it also has CN¥4.71b in cash, leading to a CN¥3.18b net cash position.
How Strong Is Jihua Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Jihua Group had liabilities of CN¥7.14b due within 12 months and liabilities of CN¥1.54b due beyond that. Offsetting these obligations, it had cash of CN¥4.71b as well as receivables valued at CN¥5.51b due within 12 months. So it actually has CN¥1.55b more liquid assets than total liabilities.
This surplus suggests that Jihua Group has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Jihua Group boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Jihua Group'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.
In the last year Jihua Group had a loss before interest and tax, and actually shrunk its revenue by 2.4%, to CN¥11b. We would much prefer see growth.
So How Risky Is Jihua Group?
While Jihua Group lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥29m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. We'll feel more comfortable with the stock once EBIT is positive, given the lacklustre revenue growth. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Jihua Group (including 1 which is a bit unpleasant) .
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.
