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.' 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 note that Hualan Biological Engineering Inc. (SZSE:002007) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Hualan Biological Engineering's Debt?

As you can see below, Hualan Biological Engineering had CN¥1.00b of debt at December 2023, down from CN¥1.10b a year prior. However, it does have CN¥3.11b in cash offsetting this, leading to net cash of CN¥2.11b.

A Look At Hualan Biological Engineering's Liabilities

The latest balance sheet data shows that Hualan Biological Engineering had liabilities of CN¥2.58b due within a year, and liabilities of CN¥103.1m falling due after that. Offsetting these obligations, it had cash of CN¥3.11b as well as receivables valued at CN¥3.30b due within 12 months. So it actually has CN¥3.72b more liquid assets than total liabilities.

This surplus suggests that Hualan Biological Engineering has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Hualan Biological Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Hualan Biological Engineering has boosted its EBIT by 48%, 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 Hualan Biological Engineering 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Hualan Biological Engineering 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. In the last three years, Hualan Biological Engineering's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Hualan Biological Engineering has net cash of CN¥2.11b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 48% over the last year. So is Hualan Biological Engineering's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Hualan Biological Engineering that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.