David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Jilin Aodong Pharmaceutical Group Co., Ltd. (SZSE:000623) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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 think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Jilin Aodong Pharmaceutical Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Jilin Aodong Pharmaceutical Group had CN¥1.69b of debt, an increase on CN¥700.9m, over one year. But it also has CN¥3.08b in cash to offset that, meaning it has CN¥1.39b net cash.

How Healthy Is Jilin Aodong Pharmaceutical Group's Balance Sheet?

The latest balance sheet data shows that Jilin Aodong Pharmaceutical Group had liabilities of CN¥3.47b due within a year, and liabilities of CN¥289.0m falling due after that. On the other hand, it had cash of CN¥3.08b and CN¥1.51b worth of receivables due within a year. So it can boast CN¥823.2m more liquid assets than total liabilities.

This short term liquidity is a sign that Jilin Aodong Pharmaceutical Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Jilin Aodong Pharmaceutical Group boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Jilin Aodong Pharmaceutical Group if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Jilin Aodong Pharmaceutical Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Jilin Aodong Pharmaceutical Group 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, Jilin Aodong Pharmaceutical Group saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Jilin Aodong Pharmaceutical Group has net cash of CN¥1.39b, as well as more liquid assets than liabilities. So while Jilin Aodong Pharmaceutical Group does not have a great balance sheet, it's certainly not too bad. 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. We've identified 3 warning signs with Jilin Aodong Pharmaceutical Group , 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.

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