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. We can see that Zhejiang Medicine Co., Ltd. (SHSE:600216) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Zhejiang Medicine Carry?

The chart below, which you can click on for greater detail, shows that Zhejiang Medicine had CN¥808.7m in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥1.82b in cash, leading to a CN¥1.02b net cash position.

How Healthy Is Zhejiang Medicine's Balance Sheet?

We can see from the most recent balance sheet that Zhejiang Medicine had liabilities of CN¥2.13b falling due within a year, and liabilities of CN¥503.3m due beyond that. On the other hand, it had cash of CN¥1.82b and CN¥1.75b worth of receivables due within a year. So it actually has CN¥943.4m more liquid assets than total liabilities.

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

The modesty of its debt load may become crucial for Zhejiang Medicine if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Zhejiang Medicine's ability to maintain a healthy balance sheet going forward. 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 Medicine 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. During the last three years, Zhejiang Medicine burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Medicine has net cash of CN¥1.02b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about Zhejiang Medicine's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Zhejiang Medicine is showing 3 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.