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. We can see that Shanghai No.1 Pharmacy Co.,Ltd. (SHSE:600833) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Shanghai No.1 PharmacyLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Shanghai No.1 PharmacyLtd had CN¥96.0m of debt, an increase on none, over one year. However, it does have CN¥406.6m in cash offsetting this, leading to net cash of CN¥310.6m.

How Strong Is Shanghai No.1 PharmacyLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shanghai No.1 PharmacyLtd had liabilities of CN¥632.2m due within 12 months and liabilities of CN¥168.1m due beyond that. Offsetting this, it had CN¥406.6m in cash and CN¥298.7m in receivables that were due within 12 months. So it has liabilities totalling CN¥95.0m more than its cash and near-term receivables, combined.

Since publicly traded Shanghai No.1 PharmacyLtd shares are worth a total of CN¥3.65b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Shanghai No.1 PharmacyLtd boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is Shanghai No.1 PharmacyLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shanghai No.1 PharmacyLtd had a loss before interest and tax, and actually shrunk its revenue by 16%, to CN¥1.9b. That's not what we would hope to see.

So How Risky Is Shanghai No.1 PharmacyLtd?

While Shanghai No.1 PharmacyLtd lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of CN¥179m. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. 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 example Shanghai No.1 PharmacyLtd has 2 warning signs (and 1 which is significant) we think you should know about.

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.