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.' 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 can see that Henan Lingrui Pharmaceutical Co., Ltd. (SHSE:600285) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is Henan Lingrui Pharmaceutical's Net Debt?

As you can see below, Henan Lingrui Pharmaceutical had CN¥12.5m of debt at September 2024, down from CN¥101.8m a year prior. However, it does have CN¥956.8m in cash offsetting this, leading to net cash of CN¥944.3m.

How Strong Is Henan Lingrui Pharmaceutical's Balance Sheet?

The latest balance sheet data shows that Henan Lingrui Pharmaceutical had liabilities of CN¥1.92b due within a year, and liabilities of CN¥66.0m falling due after that. On the other hand, it had cash of CN¥956.8m and CN¥838.7m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥188.5m.

This state of affairs indicates that Henan Lingrui Pharmaceutical's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the CN¥12.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Henan Lingrui Pharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Henan Lingrui Pharmaceutical has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Henan Lingrui Pharmaceutical can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Henan Lingrui Pharmaceutical 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, Henan Lingrui Pharmaceutical actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Henan Lingrui Pharmaceutical has CN¥944.3m in net cash. The cherry on top was that in converted 129% of that EBIT to free cash flow, bringing in CN¥611m. So is Henan Lingrui Pharmaceutical's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 1 warning sign for Henan Lingrui Pharmaceutical that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.