The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Jinghua Pharmaceutical Group Co., Ltd. (SZSE:002349) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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

How Much Debt Does Jinghua Pharmaceutical Group Carry?

As you can see below, at the end of June 2024, Jinghua Pharmaceutical Group had CN¥25.9m of debt, up from CN¥10.0m a year ago. Click the image for more detail. But on the other hand it also has CN¥1.23b in cash, leading to a CN¥1.20b net cash position.

How Healthy Is Jinghua Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that Jinghua Pharmaceutical Group had liabilities of CN¥301.7m due within a year, and liabilities of CN¥17.9m falling due after that. Offsetting this, it had CN¥1.23b in cash and CN¥436.9m in receivables that were due within 12 months. So it can boast CN¥1.34b more liquid assets than total liabilities.

It's good to see that Jinghua Pharmaceutical Group has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Jinghua Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that Jinghua Pharmaceutical Group grew its EBIT by 15% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is Jinghua Pharmaceutical Group'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Jinghua Pharmaceutical Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Jinghua Pharmaceutical Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jinghua Pharmaceutical Group has net cash of CN¥1.20b, as well as more liquid assets than liabilities. The cherry on top was that in converted 103% of that EBIT to free cash flow, bringing in CN¥251m. So we don't think Jinghua Pharmaceutical Group's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Jinghua Pharmaceutical Group 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.