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. We note that WuXi AppTec Co., Ltd. (SHSE:603259) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is WuXi AppTec's Net Debt?

As you can see below, at the end of September 2024, WuXi AppTec had CN¥5.62b of debt, up from CN¥5.00b a year ago. Click the image for more detail. But on the other hand it also has CN¥14.1b in cash, leading to a CN¥8.44b net cash position.

A Look At WuXi AppTec's Liabilities

The latest balance sheet data shows that WuXi AppTec had liabilities of CN¥12.9b due within a year, and liabilities of CN¥5.73b falling due after that. Offsetting these obligations, it had cash of CN¥14.1b as well as receivables valued at CN¥9.55b due within 12 months. So it can boast CN¥4.95b more liquid assets than total liabilities.

This surplus suggests that WuXi AppTec has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that WuXi AppTec has more cash than debt is arguably a good indication that it can manage its debt safely.

But the other side of the story is that WuXi AppTec saw its EBIT decline by 6.8% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 WuXi AppTec 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. WuXi AppTec 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. Looking at the most recent three years, WuXi AppTec recorded free cash flow of 48% of its EBIT, which is weaker 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 WuXi AppTec has net cash of CN¥8.44b, as well as more liquid assets than liabilities. So we are not troubled with WuXi AppTec's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with WuXi AppTec .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.