The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Zhejiang Jolly Pharmaceutical Co.,LTD (SZSE:300181) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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 Zhejiang Jolly PharmaceuticalLTD's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Zhejiang Jolly PharmaceuticalLTD had debt of CN¥214.5m, up from CN¥188.2m in one year. But on the other hand it also has CN¥1.01b in cash, leading to a CN¥796.5m net cash position.

How Strong Is Zhejiang Jolly PharmaceuticalLTD's Balance Sheet?

According to the last reported balance sheet, Zhejiang Jolly PharmaceuticalLTD had liabilities of CN¥754.9m due within 12 months, and liabilities of CN¥75.3m due beyond 12 months. Offsetting this, it had CN¥1.01b in cash and CN¥535.5m in receivables that were due within 12 months. So it can boast CN¥716.4m more liquid assets than total liabilities.

This surplus suggests that Zhejiang Jolly PharmaceuticalLTD has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Jolly PharmaceuticalLTD 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 Zhejiang Jolly PharmaceuticalLTD has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Jolly PharmaceuticalLTD's ability to maintain a healthy balance sheet going forward. 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. Zhejiang Jolly PharmaceuticalLTD 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, Zhejiang Jolly PharmaceuticalLTD produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Jolly PharmaceuticalLTD has CN¥796.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 36% over the last year. So is Zhejiang Jolly PharmaceuticalLTD'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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Zhejiang Jolly PharmaceuticalLTD you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.