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. As with many other companies Tasly Pharmaceutical Group Co., Ltd (SHSE:600535) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Tasly Pharmaceutical Group's Net Debt?

The image below, which you can click on for greater detail, shows that Tasly Pharmaceutical Group had debt of CN¥2.53b at the end of June 2024, a reduction from CN¥3.17b over a year. However, its balance sheet shows it holds CN¥5.80b in cash, so it actually has CN¥3.26b net cash.

How Strong Is Tasly Pharmaceutical Group's Balance Sheet?

We can see from the most recent balance sheet that Tasly Pharmaceutical Group had liabilities of CN¥3.30b falling due within a year, and liabilities of CN¥1.46b due beyond that. On the other hand, it had cash of CN¥5.80b and CN¥2.04b worth of receivables due within a year. So it actually has CN¥3.07b more liquid assets than total liabilities.

This short term liquidity is a sign that Tasly Pharmaceutical Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tasly Pharmaceutical Group has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Tasly Pharmaceutical Group saw its EBIT drop by 8.5% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Tasly Pharmaceutical Group 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Tasly Pharmaceutical Group 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. Happily for any shareholders, Tasly Pharmaceutical Group actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While it is always sensible to investigate a company's debt, in this case Tasly Pharmaceutical Group has CN¥3.26b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 130% of that EBIT to free cash flow, bringing in CN¥2.0b. So we don't think Tasly Pharmaceutical Group's use of debt is risky. 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. Be aware that Tasly Pharmaceutical Group is showing 2 warning signs in our investment analysis , you should know about...

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.