Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Sunshine Guojian Pharmaceutical (Shanghai) Co., Ltd (SHSE:688336) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Sunshine Guojian Pharmaceutical (Shanghai)'s Net Debt?

The chart below, which you can click on for greater detail, shows that Sunshine Guojian Pharmaceutical (Shanghai) had CN¥50.0m in debt in September 2024; about the same as the year before. But it also has CN¥1.32b in cash to offset that, meaning it has CN¥1.27b net cash.

A Look At Sunshine Guojian Pharmaceutical (Shanghai)'s Liabilities

The latest balance sheet data shows that Sunshine Guojian Pharmaceutical (Shanghai) had liabilities of CN¥760.6m due within a year, and liabilities of CN¥111.7m falling due after that. On the other hand, it had cash of CN¥1.32b and CN¥241.9m worth of receivables due within a year. So it actually has CN¥687.7m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Sunshine Guojian Pharmaceutical (Shanghai) has boosted its EBIT by 45%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Sunshine Guojian Pharmaceutical (Shanghai) 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. While Sunshine Guojian Pharmaceutical (Shanghai) 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 two years, Sunshine Guojian Pharmaceutical (Shanghai)'s free cash flow amounted to 38% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sunshine Guojian Pharmaceutical (Shanghai) has net cash of CN¥1.27b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 45% over the last year. So we don't think Sunshine Guojian Pharmaceutical (Shanghai)'s use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Sunshine Guojian Pharmaceutical (Shanghai) (1 is a bit unpleasant) you should be aware of.

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.

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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.