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. Importantly, Guangzhou Wondfo Biotech Co.,Ltd (SZSE:300482) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 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. When we think about a company's use of debt, we first look at cash and debt together.

How Much Debt Does Guangzhou Wondfo BiotechLtd Carry?

The chart below, which you can click on for greater detail, shows that Guangzhou Wondfo BiotechLtd had CN¥564.0m in debt in September 2024; about the same as the year before. But it also has CN¥2.11b in cash to offset that, meaning it has CN¥1.55b net cash.

A Look At Guangzhou Wondfo BiotechLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Guangzhou Wondfo BiotechLtd had liabilities of CN¥504.8m due within 12 months and liabilities of CN¥678.7m due beyond that. On the other hand, it had cash of CN¥2.11b and CN¥960.4m worth of receivables due within a year. So it actually has CN¥1.89b more liquid assets than total liabilities.

This surplus suggests that Guangzhou Wondfo BiotechLtd is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Guangzhou Wondfo BiotechLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

In addition to that, we're happy to report that Guangzhou Wondfo BiotechLtd has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Guangzhou Wondfo BiotechLtd 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. Guangzhou Wondfo BiotechLtd 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. Over the most recent three years, Guangzhou Wondfo BiotechLtd recorded free cash flow worth 51% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While it is always sensible to investigate a company's debt, in this case Guangzhou Wondfo BiotechLtd has CN¥1.55b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 38% over the last year. So we don't think Guangzhou Wondfo BiotechLtd's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Guangzhou Wondfo BiotechLtd that you should be aware of before investing here.

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.