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.' 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. As with many other companies Zhejiang Xianju Pharmaceutical Co.,Ltd. (SZSE:002332) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. 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 Xianju PharmaceuticalLtd's Net Debt?

As you can see below, Zhejiang Xianju PharmaceuticalLtd had CN¥197.4m of debt at March 2024, down from CN¥328.4m a year prior. But it also has CN¥1.67b in cash to offset that, meaning it has CN¥1.47b net cash.

How Healthy Is Zhejiang Xianju PharmaceuticalLtd's Balance Sheet?

The latest balance sheet data shows that Zhejiang Xianju PharmaceuticalLtd had liabilities of CN¥1.12b due within a year, and liabilities of CN¥110.0m falling due after that. Offsetting these obligations, it had cash of CN¥1.67b as well as receivables valued at CN¥899.6m due within 12 months. So it actually has CN¥1.34b more liquid assets than total liabilities.

This surplus suggests that Zhejiang Xianju PharmaceuticalLtd has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Zhejiang Xianju PharmaceuticalLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

But the bad news is that Zhejiang Xianju PharmaceuticalLtd has seen its EBIT plunge 10% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Zhejiang Xianju PharmaceuticalLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Zhejiang Xianju 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. During the last three years, Zhejiang Xianju PharmaceuticalLtd produced sturdy free cash flow equating to 57% 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 we empathize with investors who find debt concerning, you should keep in mind that Zhejiang Xianju PharmaceuticalLtd has net cash of CN¥1.47b, as well as more liquid assets than liabilities. So we are not troubled with Zhejiang Xianju 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. Be aware that Zhejiang Xianju PharmaceuticalLtd is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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