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 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. We can see that Shenyang Xingqi Pharmaceutical Co.,Ltd. (SZSE:300573) 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 is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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.

What Is Shenyang Xingqi PharmaceuticalLtd's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Shenyang Xingqi PharmaceuticalLtd had debt of CN¥50.0m, up from none in one year. However, its balance sheet shows it holds CN¥425.4m in cash, so it actually has CN¥375.4m net cash.

How Strong Is Shenyang Xingqi PharmaceuticalLtd's Balance Sheet?

We can see from the most recent balance sheet that Shenyang Xingqi PharmaceuticalLtd had liabilities of CN¥248.9m falling due within a year, and liabilities of CN¥74.8m due beyond that. Offsetting this, it had CN¥425.4m in cash and CN¥258.4m in receivables that were due within 12 months. So it can boast CN¥360.1m more liquid assets than total liabilities.

Having regard to Shenyang Xingqi PharmaceuticalLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CN¥19.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Shenyang Xingqi PharmaceuticalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shenyang Xingqi PharmaceuticalLtd's saving grace is its low debt levels, because its EBIT has tanked 38% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shenyang Xingqi PharmaceuticalLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Shenyang Xingqi PharmaceuticalLtd 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 three years, Shenyang Xingqi PharmaceuticalLtd's free cash flow amounted to 36% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Shenyang Xingqi PharmaceuticalLtd has CN¥375.4m in net cash and a decent-looking balance sheet. So we are not troubled with Shenyang Xingqi PharmaceuticalLtd's debt use. 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. We've identified 1 warning sign with Shenyang Xingqi PharmaceuticalLtd , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.