Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shenzhen YHLO Biotech Co., Ltd. (SHSE:688575) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Shenzhen YHLO Biotech Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Shenzhen YHLO Biotech had debt of CN¥579.6m, up from CN¥453.5m in one year. However, its balance sheet shows it holds CN¥653.3m in cash, so it actually has CN¥73.6m net cash.

How Strong Is Shenzhen YHLO Biotech's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Shenzhen YHLO Biotech had liabilities of CN¥792.1m due within 12 months and liabilities of CN¥480.5m due beyond that. Offsetting this, it had CN¥653.3m in cash and CN¥460.8m in receivables that were due within 12 months. So it has liabilities totalling CN¥158.5m more than its cash and near-term receivables, combined.

This state of affairs indicates that Shenzhen YHLO Biotech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the CN¥12.9b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Shenzhen YHLO Biotech also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Shenzhen YHLO Biotech's saving grace is its low debt levels, because its EBIT has tanked 72% 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 ultimately the future profitability of the business will decide if Shenzhen YHLO Biotech can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shenzhen YHLO 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. In the last three years, Shenzhen YHLO Biotech created free cash flow amounting to 14% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shenzhen YHLO Biotech has CN¥73.6m in net cash. So we don't have any problem with Shenzhen YHLO Biotech's use of debt. 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. For example, we've discovered 2 warning signs for Shenzhen YHLO Biotech (1 is significant!) that you should be aware of before investing here.

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.

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