Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Mayinglong Pharmaceutical Group Co., Ltd. (SHSE:600993) does use debt in its business. But is this debt a concern to shareholders?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Mayinglong Pharmaceutical Group

What Is Mayinglong Pharmaceutical Group's Net Debt?

As you can see below, at the end of June 2023, Mayinglong Pharmaceutical Group had CN¥462.8m of debt, up from CN¥38.0m a year ago. Click the image for more detail. But it also has CN¥3.17b in cash to offset that, meaning it has CN¥2.71b net cash.

A Look At Mayinglong Pharmaceutical Group's Liabilities

The latest balance sheet data shows that Mayinglong Pharmaceutical Group had liabilities of CN¥788.1m due within a year, and liabilities of CN¥604.0m falling due after that. Offsetting these obligations, it had cash of CN¥3.17b as well as receivables valued at CN¥632.0m due within 12 months. So it actually has CN¥2.41b more liquid assets than total liabilities.

This surplus suggests that Mayinglong Pharmaceutical Group is using debt in a way that is appears to be both safe and conservative. 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 Mayinglong Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Mayinglong Pharmaceutical Group's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is Mayinglong 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. Mayinglong 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. During the last three years, Mayinglong Pharmaceutical Group produced sturdy free cash flow equating to 60% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Mayinglong Pharmaceutical Group has net cash of CN¥2.71b, as well as more liquid assets than liabilities. So is Mayinglong Pharmaceutical Group'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. To that end, you should learn about the 2 warning signs we've spotted with Mayinglong Pharmaceutical Group (including 1 which doesn't sit too well with us) .

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.