Warren Buffett famously said, '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. Importantly, Zhejiang Jiuzhou Pharmaceutical Co., Ltd (SHSE:603456) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 Zhejiang Jiuzhou Pharmaceutical Carry?

As you can see below, at the end of March 2024, Zhejiang Jiuzhou Pharmaceutical had CN¥1.70b of debt, up from CN¥759.5m a year ago. Click the image for more detail. But on the other hand it also has CN¥4.06b in cash, leading to a CN¥2.36b net cash position.

How Strong Is Zhejiang Jiuzhou Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Zhejiang Jiuzhou Pharmaceutical had liabilities of CN¥2.82b due within a year, and liabilities of CN¥697.3m falling due after that. On the other hand, it had cash of CN¥4.06b and CN¥1.65b worth of receivables due within a year. So it actually has CN¥2.19b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Jiuzhou Pharmaceutical is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Zhejiang Jiuzhou Pharmaceutical has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Zhejiang Jiuzhou Pharmaceutical has seen its EBIT plunge 15% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Zhejiang Jiuzhou Pharmaceutical 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 Zhejiang Jiuzhou Pharmaceutical 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, Zhejiang Jiuzhou Pharmaceutical's free cash flow amounted to 26% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Jiuzhou Pharmaceutical has CN¥2.36b in net cash and a decent-looking balance sheet. So we don't have any problem with Zhejiang Jiuzhou Pharmaceutical's use of debt. 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. Be aware that Zhejiang Jiuzhou Pharmaceutical is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.

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