Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Kangmei Pharmaceutical Co., Ltd. (SHSE:600518) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Kangmei Pharmaceutical

What Is Kangmei Pharmaceutical's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Kangmei Pharmaceutical had debt of CN¥33.0m, up from CN¥26.4m in one year. However, it does have CN¥1.19b in cash offsetting this, leading to net cash of CN¥1.15b.

A Look At Kangmei Pharmaceutical's Liabilities

According to the last reported balance sheet, Kangmei Pharmaceutical had liabilities of CN¥5.15b due within 12 months, and liabilities of CN¥2.58b due beyond 12 months. Offsetting this, it had CN¥1.19b in cash and CN¥2.67b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CN¥3.87b.

Since publicly traded Kangmei Pharmaceutical shares are worth a total of CN¥25.5b, 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. While it does have liabilities worth noting, Kangmei Pharmaceutical also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kangmei Pharmaceutical will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Kangmei Pharmaceutical wasn't profitable at an EBIT level, but managed to grow its revenue by 32%, to CN¥5.0b. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Kangmei Pharmaceutical?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Kangmei Pharmaceutical had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of CN¥749m and booked a CN¥2.0b accounting loss. With only CN¥1.15b on the balance sheet, it would appear that its going to need to raise capital again soon. With very solid revenue growth in the last year, Kangmei Pharmaceutical may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with Kangmei Pharmaceutical , and understanding them should be part of your investment process.

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.