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.' 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 Sunflower Pharmaceutical Group Co.,Ltd (SZSE:002737) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

What Is Sunflower Pharmaceutical GroupLtd's Net Debt?

As you can see below, Sunflower Pharmaceutical GroupLtd had CN¥13.7m of debt at March 2024, down from CN¥430.0m a year prior. However, it does have CN¥3.80b in cash offsetting this, leading to net cash of CN¥3.78b.

How Strong Is Sunflower Pharmaceutical GroupLtd's Balance Sheet?

The latest balance sheet data shows that Sunflower Pharmaceutical GroupLtd had liabilities of CN¥1.52b due within a year, and liabilities of CN¥352.8m falling due after that. Offsetting these obligations, it had cash of CN¥3.80b as well as receivables valued at CN¥223.6m due within 12 months. So it actually has CN¥2.15b more liquid assets than total liabilities.

This surplus suggests that Sunflower Pharmaceutical GroupLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Sunflower Pharmaceutical GroupLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Sunflower Pharmaceutical GroupLtd's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sunflower Pharmaceutical GroupLtd will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sunflower Pharmaceutical GroupLtd 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. Over the last three years, Sunflower Pharmaceutical GroupLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Sunflower Pharmaceutical GroupLtd has net cash of CN¥3.78b, as well as more liquid assets than liabilities. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in CN¥718m. So we don't have any problem with Sunflower Pharmaceutical GroupLtd's use of debt. 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 Sunflower Pharmaceutical GroupLtd you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com