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.' 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. Importantly, Zhejiang Jolly Pharmaceutical Co.,LTD (SZSE:300181) does carry debt. But the more important question is: how much risk is that debt creating?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

What Is Zhejiang Jolly PharmaceuticalLTD's Net Debt?

The chart below, which you can click on for greater detail, shows that Zhejiang Jolly PharmaceuticalLTD had CN¥240.7m in debt in June 2024; about the same as the year before. But on the other hand it also has CN¥925.9m in cash, leading to a CN¥685.2m net cash position.

A Look At Zhejiang Jolly PharmaceuticalLTD's Liabilities

The latest balance sheet data shows that Zhejiang Jolly PharmaceuticalLTD had liabilities of CN¥1.12b due within a year, and liabilities of CN¥50.7m falling due after that. Offsetting this, it had CN¥925.9m in cash and CN¥864.7m in receivables that were due within 12 months. So it can boast CN¥615.5m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Zhejiang Jolly PharmaceuticalLTD has boosted its EBIT by 41%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Zhejiang Jolly PharmaceuticalLTD's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Zhejiang Jolly 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. Looking at the most recent three years, Zhejiang Jolly PharmaceuticalLTD recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case Zhejiang Jolly PharmaceuticalLTD has CN¥685.2m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 41% over the last year. So we don't think Zhejiang Jolly PharmaceuticalLTD's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Zhejiang Jolly PharmaceuticalLTD you should know about.

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.

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