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 Sansure Biotech Inc. (SHSE:688289) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Sansure Biotech's Debt?

The image below, which you can click on for greater detail, shows that at September 2023 Sansure Biotech had debt of CN¥20.4m, up from none in one year. But on the other hand it also has CN¥4.81b in cash, leading to a CN¥4.79b net cash position.

How Healthy Is Sansure Biotech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sansure Biotech had liabilities of CN¥771.8m due within 12 months and liabilities of CN¥106.9m due beyond that. On the other hand, it had cash of CN¥4.81b and CN¥852.4m worth of receivables due within a year. So it actually has CN¥4.79b more liquid assets than total liabilities.

This surplus liquidity suggests that Sansure Biotech's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Sansure Biotech boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sansure Biotech's saving grace is its low debt levels, because its EBIT has tanked 81% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sansure Biotech'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sansure Biotech 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, Sansure Biotech produced sturdy free cash flow equating to 78% 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 Sansure Biotech has CN¥4.79b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 78% of that EBIT to free cash flow, bringing in CN¥617m. So is Sansure Biotech's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Sansure Biotech you should be aware of.

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.